By Dhirendra Kumar
August 4, 2009

As every mutual fund investor in the country must know (or should know) by now, entry loads on mutual funds have been abolished from August 1. Now, the entirety of the sum you invest will actually get invested in your name. Entry loads were used by funds to help remunerate the fund distributor who serviced you. Now, you will have to separately pay the distributor for his services an amount that you can mutually fix with him as fair payment for his services.

Apart from entry loads, there are some accompanying changes in the rules that investors must understand. The most important is the vastly enhanced incidence of exit load in equity funds. Earlier, exit loads in funds were generally around one per cent for amounts withdrawn within one year and zero afterwards. Above a certain amount, which used to range from Rs 2 to 5 crore, the loads were lower.

Now all, or some, of these parameters have been tightened by all fund companies. The period has been enhanced to 2 or 3 years, the amount limit has been lowered and in some cases, the percentages have also been enhanced to 2 per cent, specially for periods under a year. Generally, investors can count on zero exit loads only for investment periods longer than three years. These are early days and it’s possible that exit loads may evolve. Exit loads are going to acquire more importance now and one can expect some standardisation across the industry.

Exit loads are supposed to deter investors from pulling out their money quickly. Under the new regulations, up to one per cent of the exit load can be used by the funds for their own expenses. The way things are shaping up, it looks like fund companies will be paying distributors one per cent up front commission even though there’s no entry load. If the investor exits the fund within a year, then the commission gets compensated from the exit load. In any case, investors now need to be aware of the exit load factor.

Besides exit load, there’s another part of the new regulations that investors need to pay attention to. One of the goals of the Securities and Exchange Board of India’s (SEBI) new regulations was to eliminate or reduce ‘churn’. Churn was the practice of distributors of repeatedly getting the investor to switch money between funds because each switch earns commission. This commission could be as high as three or even four per cent. Now, with entry loads gone, this commission will be down to perhaps one per cent, but not zero.
That means that the motive for churning is not gone. In fact, from the point of view of an unscrupulous distribution organisation, a commission of one per cent instead of three simply means that they have to churn three times as much to earn the same revenues.

Fortunately, SEBI has also given investors a tool to protect themselves against this. Distributors are now obliged to reveal to investors what commissions fund companies pay them. They are even obliged to reveal what commissions competing fund companies would have paid them. In the run-up to August 1, this aspect of the new regulation has received the least attention. However, if investors are to benefit fully, then this transparency could prove to be the most important.

--Syndicated from Value Research Online--