SEBI to scrap amortisation in closed-ended funds

MUMBAI: Big-Budget promotional campaigns for new-fund offerings from mutual fund houses could soon be a thing of the past. More specifically, asset management companies (AMCs) can still go in for extravagant ad campaigns, but investors can’t be billed for it.

Capital market regulator Securities and Exchange Board of India (SEBI) is planning to scrap the regulation that allows MFs launching closed-ended funds to amortise the initial issue expenses.

And since closed-ended funds are not allowed to charge ‘entry loads’, fund houses will now have to pay for the fund marketing expenses and distributor commissions through the asset management fees they collect. Two years ago, SEBI had abolished this regulation for open-ended schemes.

‘Amortisation of initial issue expenses’ is an accounting procedure that allows funds to spend the amount collected as fees, when the new fund offer is on (currently, about 6% for a three-year fund) in stages, and not at one go. Typically, about 3% is paid to brokers as commission while the rest is used to pay for the billboards, television spots and other marketing expenses.

Sources said the new regulation may be announced next week. The launch of a slew of close-ended funds in the past couple of months is being viewed by industry sources as a pre-emptive move on AMCs’ part.

Following the SEBI move to scrap the amortisation benefit for open-ended schemes, there was a sudden spurt in closed-ended scheme launches. Of the 34 new fund offers in 2007, as many as 24 were closed-ended. While investors will benefit from the move tremendously, its implication on the asset management industry will be mixed.

MF houses will not have any special incentive to launch closed-ended funds, as the existing regulation allowed them to tap into the investor money to pay for distributor commissions and advertisements.

Distributors will now look to sell more open-ended funds to investors, as they stand to get better commissions, if the amortisation in closed-ended funds is banned. AMCs will have to dig into their asset management fees (approximately 1% per year of the then assets) to pay for all this. Naturally, their profitability will be affected.

“Investors and media have created a big hue and cry about Sebi banning entry fees in funds, without realising that this amount is only a small part of the income for fund houses,” says a Mumbai-based financial planner, who did not wish to be quoted.

“It may appear tiny at 1%, but the biggest chunk of income for fund houses are asset management fees,” he suggests. The way our markets (and hence assets under management) are soaring, this fee component is also zooming and, hence the move will not make much of a difference, says this financial planner.

A marketing officer at a fund house felt that banning amortisation will force funds to come out with closed-ended funds, only if the proposed investment concept deserved such a structure. “For instance, a small mid-cap fund should be closed-ended, but certainly not a large-cap one,” he remarked.

SEBI recently allowed investors to save on initial fees in open-ended funds if they approach fund houses directly and not through a broker. This, along with banning of amortisation in closed-ended funds, will be one of the most important policy moves that is expected to change the face of the industry in the coming years.