Fee caps to dent profits for MFs by 30% or more, predicts Jefferies study

The introduction of the proposed fee caps for mutual fund schemes may potentially drive the profits of asset management companies (AMCs) down 30 percent.

Larger AMCs may face an even greater impact, with profits taking up to a 50 percent dent. Lower fees imposed on larger funds could discourage consolidation and merger and acquisition (M&A) activities within the sector.

“Ceteris paribus, the impact on profit from change in equity-linked TER could be 30 percent of profit. This should rise as select debt funds that get higher TER than new caps (like credit funds, duration funds) are included and arbitrage funds slip into losses. The impact on profits is also divergent (1) Top-5 funds should see 50 percent fall in profit, (2) Next-5 a 17 percent fall, (3) Next-10 a 37 percent rise, (4) Next-10 a 28 percent fall and (5) others (below #30) a 25 percent rise,” a Jefferies report said.

According to recent calculations by Jefferies, proposed fee caps on equity-linked assets under management (AUMs) of mutual funds could result in a 30 basis point (bps) decrease in equity fees for large asset management companies (AMCs). Conversely, smaller AMCs with AUMs below $10 billion may experience an increase of approximately 10 bps. This divergence in fees, ranging from 60 to 100 bps, could potentially lead to a loss of market share for small AMCs, with larger ones benefiting.

Sebi has recently proposed a uniform total expense ratio (TER) across mutual fund schemes, in an effort to bring greater transparency in the costs charged to unitholders.

“The norms will have much higher impact on Top-5 MFs and enable 20 MFs to draw additional blended yields on equity-oriented AUMs. This reflects a large equity-oriented AUM-base of Top-5 players that have more than 50 percent share in the sector. We also believe that less than Rs1 trillion worth of arbitrage fund segment may need to be wound down as MF’s will incur loss on them due to inability to recover transaction costs,” the Jefferies report said.

“We estimate a big divergence in impact as (1) Top-5 funds should see 30bps fall in TER, (2) Next-5 a 10bps fall, (3) Next-10 a 12bps rise, (4) Next-10 a 4bps fall and (5) others (below #30) a 11bps rise. While smaller MFs should gain higher TER, we believe that risk of disruption exists if larger MFs aggressively advertise their 60-100bps lower TERs to gain market share in AUMs to offset revenue impact,” the Jefferies report added.

Assets under management are already under pressure since the start of the year amid various factors such as the government’s alterations in the tax structure for debt funds, increasing competition, and removal of long term indexation benefit.

Year-to-date, Aditya Birla Asset fell 18 percent, HDFC AMC 11 percent, UTI AMC 17 percent, and Nippon Life fell 1.7 percent.

The new proposed changes are part of Sebi’s plan to improve transparency and pass the benefit of larger scale to investors. The market regulator has also sought to improve linkage of charges/ TER with fund-performance.

Jefferies expects that the AMCs have the potential to mitigate the impact of fee caps by sharing the burden with various stakeholders in their value chain, including distributors, stock brokers, and RTA partners, among others. By distributing the impact across the value chain, AMCs can reduce the overall financial strain on themselves.

In addition, adjusting fee caps for arbitrage funds, creating headroom for securities transaction tax (STT), and balancing total expense ratios (TERs) can also help lower the impact of the proposed fee caps. These measures aim to provide some flexibility and alleviate the financial pressures faced by AMCs, the report adds.