How Fund Houses Are Trying To Sabotage SEBI’s Expense Ratio Reforms

Seeing the things that some fund houses do, frequently gives me the feeling of watching cheap crooks in action.  The type that get a thrill from travelling without a ticket.  The type that like to steal from the weak and elderly.  The type that give a stupid grin when caught with their hands in the cookie jar.  Except that there’s nothing cheap about the scale on which fund houses operate.

It’s been a month since SEBI’s disclosure norms for expense ratios came into effect.  They were among the most significant set of reforms undertaken by SEBI in recent times.  They were intended to boost transparency, and bring down costs.  Yet the fact is that some fund houses have lacked the ability to appreciate the spirit of those moves, while others have plain ignored it. Worse still, some fund houses have shown no respect for investors or for SEBI and have, in effect, mocked the process of reforms (see here, for example).  In this post, I want to give a sense of how widespread this is.  I will talk specifically on one key issue i.e. the expense ratio files that fund houses have put up on their websites.  I hope to spotlight the questionable approach of multiple fund houses, and the message that they appear to be giving to their investors. It is based on what I have seen across the websites of select fund houses: it is not an exhaustive analysis. 

“Don’t visit our website!”
On many fund house websites, locating the expense ratio file can be a tall order.  It might be under disclosures, or under downloads, or somewhere else.  Probably no fund house has made it tougher to locate the file than Kotak Mahindra MF.  Leave aside the fact that its website is a sprawling mess, or that it does not seem to have even the option for a search.  When I tried looking for the file, I just couldn’t find the link.  It wasn’t even on the sitemap.  Finally, I had to do a search on Google to get to the file.  Just so that you know, when it comes to other fund houses, doing a search on Google isn’t going to necessarily help.

“We’re going to make it really difficult for you!”
What if you want to compare expense ratios across all schemes of a fund house?  Many fund houses have presented their data in such a manner that it is not easy to do so.  Some, such as IDFC MF and Kotak Mahindra MF have given the data for each scheme in a separate sheet, making it a gruelling task to do such comparisons.  Others like  ICICI Prudential MF and SBI MF have made the task even more laborious because they have opted to have separate files for each scheme.  Thus, instead of a single download, they expect you to make multiple downloads, each time you want to see the data.  And given the number of schemes that they have, that, by itself, could take a really long time. 

“We’re going to make it really, really difficult for you, and we don’t care what SEBI thinks!”
Getting expense ratio information from the HDFC MF website poses a different level of difficulty.   The fund house first wants you to decide whether you want current data or historical data.  If it is historical data, then you are expected to put in a date range.  Thereafter, just like ICICI Prudential MF and SBI MF, you have to download the data for each scheme separately.  Last, but not the least, the information in the files is presented in a format that is different from what SEBI has stipulated.  As a result, if you simply want to compare expenses across direct and regular plans of a single scheme, doing so is an uphill task.

“We’re going to drive you nuts, and SEBI can’t do a thing about it!”
In what I would describe as a drastic departure from SEBI’s format, DSP BlackRock MF and IDBI MF (and possibly others) have opted to give the expense ratios for each date in a separate file.  Consequently, if you want to examine the date-wise expense ratios in any single scheme, be prepared for a nightmarish experience.  In the case of IDBI MF, if you want to compare expense ratios across schemes on any single date, that task will also prove to be arduous because the information for each scheme is in a separate sheet.  In my opinion, of all the fund houses, the approach taken by IDBI MF is either the most harebrained or the most sadistic.

“We’re the most investor-friendly!”
I have to admit that, going into this exercise, I did not expect UTI MF to emerge as the best example of a fund house conforming to SEBI’s disclosure.  Fact is, it was a delight to see what the fund house has done: I just hope that they keep it up.  All you need to do is to select a date range.  You can then download the daily expense ratios across all schemes, exactly the way SEBI has specified, and all in a single sheet.  What’s more, the scheme names are entered in such a way that using the feature of filters in Excel, you can easily make comparisons across schemes.  I am not sure if what they have done can be improved but as things stand, every fund house should at least follow their lead.

Total Return Index Benchmarking

Around six weeks ago, DSP BlackRock MF stated its intention to “compare its funds’ performance” to the total return of their respective benchmark indices.  A few days later, Edelweiss MF made a similar announcement.  While these were noteworthy decisions, I couldn’t quite understand the need for these fund houses to formally proclaim their intentions to the world at large.  To be honest, a part of me felt that these announcements had a holier-than-thou ring about them.  More than that, though, it was the wide media coverage of these announcements that stood out for me.  Sure, it was helpful in spreading awareness about the difference between a Total Return Index (TRI) and a Price Return Index (PRI).  But beyond that, it seemed to me that most of the coverage was hype and lacked clear perspective.  In this post, I’d like to chip in with some scattered thoughts.

TRI benchmarking has little to do with appropriateness
By any reasonable standard, the appropriateness of a scheme’s benchmark index is determined by the similarity of the constituents of the benchmark with the universe of securities that the scheme will invest into.  So, for a scheme that invests in large cap stocks, the Nifty 50 or the BSE Sensex could both be appropriate benchmarks.  It is a fund house’s individual decision as to which index to choose as the formal benchmark.  As for choosing a TRI over a PRI, that has little to do with appropriateness in that sense: it is more like raising the height of a hurdle to jump over. If a fund house chooses a TRI over a PRI, then at best it can be assumed to be signalling its intent to raise the bar for its performance.  Bear in mind, though, that a fund house can raise the bar for its performance in any number of ways, and without making such announcements. 

Where will performance be reported?
Even if a fund house chooses TRI benchmarking, its performance reporting will be restricted to documents that are released by it (e.g. fact sheets, SID, KIM etc.).  So, to investors who prefer to compare scheme performances across multiple fund houses, such reporting will be of little use. 

Investors can choose their own benchmark
No matter what benchmark index a fund house chooses, in analyzing the performance of a scheme, an investor is always free to use whatever benchmark index he or she thinks appropriate.  For example, in all instances of index data used by me on both my blogs, I have used total return numbers only.  It is not as if that is necessarily better than using price return numbers: it is merely an expression of my personal belief.  And I have done so, regardless of what practice the industry or individual fund houses have followed.

The notion of “alpha” varies
There are some who argue that a TRI is a better choice for accurately determining “alpha”.  In my opinion, a lot depends upon how one defines “alpha”.  For those who regard “alpha” as a mathematical formula, it is understandable for them to prefer a TRI over a PRI.  But in my experience, for most people who look for “alpha”, it is just a broad appraisement of the value added by a fund manager.  Sure enough, some of these people assess “alpha” against a TRI but there are many to whom the TRI/ PRI choice may be inconsequential.  There are also those who believe in assessing “alpha” against an appropriate index fund (rather than an index) while there are yet others who, in their own wisdom, assess “alpha” against the returns from a bank deposit.

TRI benchmarking is not new in India
In conversations with investors and advisors, I gathered that quite a few of them were under the impression that these announcements were pioneering/ ground-breaking in the context of the Indian fund industry.  In fact, there was at least one report, in The Economic Times, which credited DSPBR MF as “the first fund house to start with this practice”.  The truth is that Quantum MF has been following TRI benchmarking for years, for both its equity schemes, as well for its Nifty ETF.  Other fund houses following this practice selectively include IDBI MF and Kotak MF (thanks to one scheme taken over from the erstwhile Pinebridge MF).  And then there are some fund houses that have taken a somewhat convoluted approach, if I may call it that.  To take an example, SBI MF compares the returns of its Nifty Index Fund with the Nifty 50 PRI, but measures its tracking error against the Nifty 50 TRI.  As far as I am aware, none of these fund houses trumpeted their decisions and perhaps, for that reason, these haven’t attracted the media coverage that the more recent announcements have.

Excessively Expensive Income Funds

For some time now, I have been trying to maintain a watch list of the most expensive plans among income funds.  While expenses matter regardless of fund category, in the case of income funds they have a more consistent and harder impact (than, say, in the case of equity or balanced funds). Much more often than not, higher expenses lead to low returns or higher risk or both. 

While pursuing this objective, one of my most striking observations has been that the plans that I consider to be excessively expensive, account for a large chunk of the AUM in the category.  If I go by last quarter’s AAUM data, then 69% of the money invested in regular plans (i.e. other than direct) of income funds (other than liquid funds and pure debt fixed maturity plans) was allocated to plans that I consider to be excessively expensive.  This could mean one of two things: either my threshold for expensiveness is too low or most investors in regular plans have been sold plans that are way too expensive.  For those who want to explore the truth of the matter, in this post I present a small selection of the income funds on my list.  But before we get into the specifics, there are a few things to bear in mind. 

Firstly, evaluating and explaining a plan’s expensiveness can be a far more complex exercise than most people realize.  In presenting the data in this post, I have opted to keep things simple (some may regard it as an oversimplification).  I have limited the scope of my presentation to non-direct plans, and have primarily focussed on each plan’s expense ratio relative to that of peer group schemes. For the purpose, I have grouped schemes into five categories.  While I have tried to keep things as objective as possible, in any discussion on expensiveness, some degree of subjectivity/ personal bias is unavoidable.

Secondly, against each scheme that I have listed, I have given the current AUM of its non-direct plans.  This is intended to serve two purposes.  For one, it tells you how much money stands invested in these expensive plans.  Additionally, it can help you better understand a plan’s expensiveness.  As a rule of thumb, schemes with larger AUM are expected to have lower expense ratios than schemes with lesser AUM.  Similarly, schemes with larger AUM than most of their peer group should ideally have expense ratios that are below the category average. 

Thirdly, bear in mind that this is a small selection of schemes from my list.  My complete list of excessively expensive plans is too long and complex to be meaningfully presented here.  The plans presented below are not necessarily the most expensive ones: they are some of the most expensive ones.  They have been handpicked to show how widespread the problem of high expenses is.

Lastly, what you see below is not the ideal way that I would like to present this information.  I am compelled to do so because of the constraining ways in which fund houses report expense ratios and AUM data, and because many fund houses frequently change their expense ratios.

Ultra Short Term Schemes
Average Current Expense Ratio: ~0.75%

	Expense Ratio Regular Plan FY 17	Current AUM Non-Direct
IDBI Ultra Short Term Fund	1.40%	410 cr
ICICI Prudential Savings Fund	1.38%	7,057 cr
SBI Savings Fund	1.36%	3,546 cr
DHFL Pramerica Low Duration Fund *	1.24%	686 cr
HDFC Cash Management Fund - Treasury Advantage Plan	1.13%	10,768 cr

With one exception, this category covers all schemes currently classified by Value Research as ‘Ultra Short Term’.  Data for expense ratios has been sourced from scheme annual reports, monthly factsheets and third party sources.  Data for AUM has been sourced from latest available AAUM disclosures and includes AUM for plans that have been suspended for fresh investments. Schemes whose expense ratios are shaded in yellow have above-average AUM in the category.

* One plan in which fresh sales have been suspended since 2012 but in which there continues to be AUM had an expense ratio of 2.51% in FY 17.

Short Term Schemes
Average Current Expense Ratio: ~0.94%

	Expense Ratio Regular Plan FY 17	Current AUM Non-Direct
HDFC Regular Saving Fund *	1.79%	4,517 cr
Franklin India Short Term Income Plan	1.57%	7,000 cr
Sundaram Select Debt Short Term Asset Plan	1.48%	307 cr
Aditya Birla Sun Life Short Term Opportunities Fund	1.40%	4,605 cr
IDFC Super Saver Income Fund - Medium Term Plan	1.31%	2,057 cr
ICICI Prudential Short Term Fund	1.24%	6,329 cr

This category covers all schemes currently classified by Value Research as ‘Short Term’.  Data for expense ratios has been sourced from scheme annual reports, monthly factsheets and third party sources.  Data for AUM has been sourced from latest available AAUM disclosures and includes AUM for plans that have been suspended for fresh investments.  Schemes whose expense ratios are shaded in yellow have above-average AUM in the category.

* (1) The expense ratio of the regular plan of HDFC Regular Savings Fund saw one of the steepest jumps in the category from 1.07% in FY 16 to 1.79% in FY 17.  (2) The expense ratio of the direct plan in FY 17 was 1.19% which was higher than the expense ratios of the regular plans of most schemes in the category.

Medium Term/ Long Term/ Dynamic Schemes
Average Current Expense Ratio: ~1.43%

In my opinion, this category as a whole, is somewhat more expensively priced than it should be.  By my reckoning, if it were to have been fairly priced, then at this point in time, the average current expense ratio for this category should have been ~1.07% (disclaimer: based on complex calculations, subjective assumptions, and personal bias).

	Expense Ratio Regular Plan FY 17	Current AUM Non-Direct
Sundaram Bond Saver	2.61%	120 cr
Sundaram Income Plus *	2.23%	117 cr
Franklin India Income Builder Fund	2.08%	872 cr
Reliance  Income Fund	2.00%	499 cr
Aditya Birla Sun Life Corporate Bond Fund	1.97%	2,947 cr
HDFC Income Fund	1.96%	1,086 cr
HDFC Corporate Debt Opportunities Fund	1.84%	10,724 cr
Franklin India Corporate Bond Opportunities Fund	1.83%	6,237 cr

With one inclusion, this category covers all schemes currently classified by Value Research as ‘Credit Opportunities’, ‘Income’ and ‘Dynamic Bond’.  The inclusion is Sundaram Income Plus which is currently classified by Value Research and Morningstar as ‘Ultra Short Term’.  Since its stated benchmark is CRISIL Composite Bond Fund Index, I feel it appropriate to include it in the present category.  Data for expense ratios has been sourced from scheme annual reports, monthly factsheets and third party sources.  Data for AUM has been sourced from latest available AAUM disclosures and includes AUM for plans that have been suspended for fresh investments. Schemes whose expense ratios are shaded in yellow have above-average AUM in the category. 

* (1) Over the last 3 financial years, the expense ratio of the regular plan of Sundaram Income Plus has seen a remarkable level of fluctuation, changing from 2.17% in FY 15 to 0.38% in FY 16 to 2.23% in FY 17.  (2) The expense ratio of the direct plan of Sundaram Income Plus in FY 17 was 0.22%.  As far as I can make out, the difference between the expense ratios of the regular plan and the direct plan of the scheme was the highest for any pure-debt scheme.

MIP Schemes
Average Current Expense Ratio: ~2.15%

In my opinion, this category as a whole, is way too expensive.  Consider this: in the case of many fund houses, if you were to create an MIP-type allocation on your own by investing in their most expensive equity scheme, and their most expensive debt scheme, that would be cheaper than investing in their MIP schemes.  By my reckoning, if it were to have been fairly priced, then at this point in time, the average current expense ratio for this category should have been ~1.26% (previous disclaimer applies).

	Expense Ratio Regular Plan FY 17	Current AUM Non-Direct
DSP BlackRock Monthly Income Plan	2.60%	447 cr
HDFC Monthly Income Plan - Short Term Plan	2.60%	322 cr
BNP Paribas Monthly Income Plan	2.59%	327 cr

This category covers open end income schemes that allow for marginal equity allocation, and which are targeted at investors seeking regular income.  Data for expense ratios has been sourced from scheme annual reports, monthly factsheets and third party sources.  Data for AUM has been sourced from latest available AAUM disclosures and includes AUM for plans that have been suspended for fresh investments.

Closed End Income Schemes With Marginal Equity 
Average Current Expense Ratio: ~2.31%

In my opinion, this is, by far, the most expensive category of income funds.  In terms of asset allocation and return potential, it is similar to the category of MIP schemes.  However, the essential running costs of these schemes are less (lesser servicing costs, lower portfolio turnover etc.).  As a result, there is a case to say that the average expense ratio in this category should be less than that of MIP schemes.  There is also a case to say that the expense ratios of many plans in this category reflect fund house-distributor collusion with the intent of milking investors, at its ugliest.  By my reckoning, if this category were to have been fairly priced, then at this point in time, the average current expense ratio should have been no more than 1.26% (previous disclaimer applies).

	Average Expense Ratio Regular Plans FY 17	Current AUM Non-Direct
HDFC Capital Protection Oriented Fund - Series III	2.69%	322 cr
DHFL Pramerica Hybrid Fixed Term Fund (Multiple Series)	2.65%	634 cr
Sundaram Hybrid Fund (Multiple Series)	2.65%	520 cr
Axis Hybrid Fund (Multiple Series) *	2.53%	6,474 cr
ICICI Prudential Multiple Yield Fund (Multiple Series)	2.51%	1,364 cr
Kotak Capital Protection Oriented Scheme (Multiple Series) ^^	2.44%	426 cr
ICICI Prudential Capital Protection Oriented Fund (Multiple Series)	2.34%	3,277 cr

Data for expense ratios has been sourced from scheme annual reports and third party sources.  Data for AUM has been sourced from latest available AAUM disclosures.  While compiling the data, only plans that were in existence on the date of compilation i.e. 21 Sep 2017 have been considered.

* 93% of  the current AUM of Axis Hybrid Fund has come via associate distributors such as Axis Bank.

^^ As far as I can make out, Kotak Mahindra MF does not follow SEBI directions/ industry practices in reporting plan-wise expense ratios in its annual reports. The expense ratio number given here includes both direct and regular plans.  The actual expense ratio for regular plans alone can be assumed to be higher than what is mentioned.