Closed-ended schemes, R.I.P
The closed-ended party is closed for the mutual fund (MF) industry. The Securities and Exchange Board of India (SEBI) on Wednesday prohibited mutual funds from charging and amortizing initial issue expenses on closed-ended schemes.
The move will hit the distributors and high net worth investors alike. Before the SEBI move, the mutual fund houses were allowed to amortize issue expenses of up to 6 per cent of the amount collected when a new scheme was launched.
So if a scheme raised Rs 1,000 crores it was allowed to recover up to Rs 60 crores as initial issue expenses from the investors investing in the scheme.
Initial issue expenses include expenses such as sales, marketing and advertising, printing and mailing, broker/agent’s commission, bank charges etc, that need to be incurred in order to get an investor to invest in a new scheme.
With this leeway of 6 per cent, some recent closed-ended fund launches, even paid commissions of as high as 5.5-5.75 per cent of the amount invested to the distributors.
The distributors, in turn, passed on part of this commission as kickback to the big investors.
For example, if a big investor invested Rs 10 lakh in a 3-year closed-ended fund, he would have paid initial issue expenses of up to Rs 60,000 over the three years.
The distributor who got bulk of this money as commission, say Rs 55,000, agreed to payback Rs 20,000 to the investor.
Now that mutual funds cannot charge the investor for initial issue expenses, there is no way it can pay its distributors such high commissions (unless it does that out of its own pocket) and hence as a result the distributors cannot pay kickbacks.
Given this, there is very little incentive for those investors who expected kickbacks to invest in closed-ended funds.
This arrangement is very similar to the practice in the life insurance space, wherein the agent passes on the part of the commission he earns back to the policyholder.
It was a win-win and win for all three parties and the closed-ended juggernaut was making merry with 38 schemes collecting over Rs 22,000 crore in the last 18 months.
At 6 per cent the total issue expenses could have been up to Rs 1,320 crore. So the investor’s money was being used to advertise as well sell the scheme.
“This 6 per cent issue expenses was a window left open by SEBI in its earlier directive. Now, with the current ruling the oversight has been corrected. It’s not the end of distributors, they will find their own ways to make money,” says Dhirendra Kumar, CEO, Valueresearconline.com, the leading independent MF research house in India.
With the entry load being done, away for those who invest directly in MFs, distributors would now have to move towards advisory roles, say experts.
Also with MFs no longer in a position to pass on the initial issue expenses to the investors, there remains very little incentive for them to launch such schemes. However, everyone does not agree with the same.
Fund houses say they will still launch closed-ended schemes, if the nature of the scheme warrants such a structure.
“It was only an added leeway, which we had till now. But now that it has been scrapped, AMCs will have to bear the expenses. Distribution expenses are going to be there. If we have to put out an ad, it has to be put out, earlier we could charge it on the fund, now we have to bear them,” says R S Srinivas Jain, chief marketing officer, SBI Mutual Fund.
He said the closed-ended structure has its own advantages as it gives the fund house the flexibility to explore opportunities in the unlisted space.
“Closed-ended schemes give the managers the extra freedom to invest in private equity. It also helps the funds to sail through volatile times such as the one we are going through. In open-ended schemes, it becomes difficult to convince the investors from redeeming their funds.”
Another senior official products division at a private mutual fund says the trend will be more towards open-ended schemes since these are easier to market. Investors are more open to the idea of withdrawing money at their convenience.
However, from the fund managers would prefer the closed variety more.
“While there will be no fundamental difference for the investor between a closed-ended and an open-ended fund, if he is making a direct application, for a fund manager, the closed-ended fund means that there is more discipline in the way funds flow. We are discussing the issue with the various stakeholders including distributors. We are having a management meet next week to deal with the situation,” the official added.
This logic can be questioned, because many closed-ended funds launched in the recent past, were not really closed, when it came to exiting the scheme. Some of them even had daily exit options.
