DOMESTIC fund houses may no longer find it attractive to launch fund of funds (FoFs), following the recent Sebi rule barring them from revenue-sharing arrangements with the schemes into which they invest. An FoF is a mutual fund scheme that invests only in other mutual funds.
While the Sebi move could sound the death knell for international feeder funds — a fund that routes money into a scheme investing in overseas markets — some industry officials feel even funds that invest in domestic schemes could be affected. According to distributors, top fund houses like ICICI, Birla Sunlife, Franklin Templeton, Fidelity, DSP Blackrock and DWS are reconsidering their plans to launch FoFs. According to the Sebi order, the Indian FoF will not be able to charge management fees on investments made by the target fund. The FoF fee structure adds up to around 3.25% annually. The fund house selling the scheme usually charges 75 basis points (0.75%) as commission from investors. It uses this money to meet marketing expenses, registrar fee and part of distributor commission. Separately, the target fund (where the money is invested) levies a fee of 1.5%-2.5% on investors in FoFs, a part of which is usually shared with the fund selling the scheme.
“By restricting revenue sharing, the
regulator intends to stop asset management charges at two points. From what we understand, it will also impact domestic FoFs, which invest into local funds,” said Ashvin Parekh, national leader-financial services, Ernst & Young.
According to Mr Parekh, most domestic FoFs follow a two-level fee pattern. Both source fund and the target fund levies about 75 bps (each) on investors as fund management charges. “The second para of the Sebi order clarifies that AMCs shall not enter into any revenue-sharing arrangement with the underlying funds and shall not receive any revenue from them. This widens the case for domestic funds as well,” said Mr Parekh.
According to experts, through this order, Sebi
intends to reduce charges on FoFs, and more specifically offshore FoFs, which have been charging investors heavily, but not yielding decent returns. Oneyear return on most FoFs has been in the range of 30-50%, much lower than category returns mapped by local funds. According to industry sources, it will no longer be profitable for fund houses to launch FoFs. An FoF occupies a special place in the product suite, as it allows a fund house to showcase investment products and asset classes that are popular in other markets. Domestic FoFs enable investors to invest across sectors and fund houses. Actually, most fund houses offering FoFs typically invest into their own sectoral funds, depriving investors an opportunity to have exposure to performing schemes run by other fund houses.
“The new changes will have implications for the viability of overseas feeder funds that fall under the FoF category, due to transfer pricing issues. But overseas funds being managed out of India will not be impacted. While this category accounts for a minor portion of industry assets today, we expect this to change over the coming years, given the benefits of international diversification,” said Jaya Prakash K, head-products, Franklin Templeton Investments.