Your MF expense ratio will soon match its performance.

The market regulator SEBI is mulling to introduce performance-linked fees said some news reports citing that the Mutual Fund Advisory Committee has recommended SEBI to introduce performance linked fee structure. This move will rationalise the total expense ratio. The matter is likely to be discussed in SEBI's Tuesday, September 18, 2018 board meeting.

According to the proposal, the mutual fund schemes that are consistently underperforming will be no longer able to charge the same total expense ratio (TER) what a better performing scheme can charge. Moreover, if fund continues with its losing streak, they may not accept fresh inflows after three years.
According to the report, if a scheme underperforms its benchmark by 2 per cent in the first year, the fund house will have to reduce its TER by 0.25 per cent. If the underperformance continues by the same margin against its benchmark for the second year in a row, TER needs to be reduced by further 0.25 per cent. Finally, in the third year of underperformance to the extent of at least 2 per cent, the scheme will have to reduce its TER, this time by 0.50 per cent. Also, such a fund house will have to close subscription for fresh sales on its scheme after three years of underperformance.

Against this, if a scheme outperforms its benchmark by 5 per cent, fund house can charge 0.25 per cent extra TER. Hence, the proposal seems to be a win-win situation for everyone as investors are paying extra TER for the extra returns that they are getting. The only challenge is to know if such outperformance is genuine or some shortcut approach has been adopted by the fund manager to spur performance temporarily.

Nonetheless, the intent seems to be right and may help bring down the TER. Already, there has been a debate on whether Indian mutual funds charge too much. There are diametrically opposite reports on this. Morningstar, a mutual fund research company in its October 2017 report said India’s average equity expense ratio is at 2.22 per cent, which is among the highest in the world. It was soon countered by another report by the Foundation of Independent Financial Advisors, that at 1.88 per cent, the ratio is the lowest among the developing nations.

Whatever may be the outcome, we are going to see TERs dipping further, which is good for the mutual fund investors.