Even though most people may understand this very well, let us define some terms at the outset so that there is no confusion.
This is charged by the fund house (AMC) to the scheme (investors money). Investors want this to be the lowest. (Conversely AMCs “may” want these to be the highest)
Entry / Exit Load Type 1
Although there is no financial term like Type 1, this is my own creation for simplicity sake. In this type, the entry and exit load (fees) go to the AMCs or Distributors. This is in addition to the expense ratio above. Obviously investors hate them.
These type of loads have been ELIMINATED in India. This elimination was not without its own share of controversies. More on this later.
Entry / Exit Load Type 2
Again there is no financial term like this. However here, the load instead of going to the AMC or the Distributor, is ploughed back to the scheme. Here the money is given back to investors. It affects the inter-se benefits / costs of different investors typically rewarding the long term investor.
In India, there are no entry loads now. There are EXIT loads which are ONLY of Type 2 where the money is ploughed back to the scheme.
Elimination of Loads of Type 1
SEBI eliminated ENTRY loads of Type one at the first instance. There was a lot of opposition to it from various quarters. However my personal view is that there were a lot of malpractices and it is good that this was eliminated.
In the second instance, SEBI eliminated EXIT load of type 1. Here, earlier AMCs were allowed to charge 1% EXIT load from the investors. While eliminating the EXIT load of type 1, SEBI also introduced an additional expense ratio of 0.2% (20 basis points).
Was the allowance of the additional 20 basis points justified to eliminate the Type 1 EXIT load of 1%? A lot of people have argued that it wasn’t. They have also provided data to support the same. I am NOT arguing that it was justified. May be it was, may be it wasn’t. As a general statement investors will always be better off with a lower expense ratio as compared to a higher expense ratio. (Why are expense ratios so high in India? It is a subject matter of another blog post.)
Regulation as it stands today
Expense ratios are tabulated and are independent of whether EXIT loads are charged or not.
ENTRY loads of all kinds are eliminated
EXIT loads where AMC / Distributors get anything are eliminated.
The ONLY kind of EXIT loads that are there are where the load is ploughed back into the scheme.
Just to be clear, TODAY, whether the exit load is NIL, 2% or 5%, the total expenses charged to investors by the AMC / Distributors are the SAME.
Invoking the additional 20 basis points argument TODAY when arguing about EXIT loads is irrelevant.
So WHY EXIT LOADS?
Introduction of Exit Loads is seen by some as an oppression on investors by the Fund Houses. Let us look at why or why not exit loads are needed.
Argument against exit loads is simple. It is the investors money. Why is the investor being penalised for taking her own money back?
The argument for exit load needs a bit of understanding of how a MF works. The Net Asset Value (NAV) is calculated based on closing stock prices of the day. Does it mean that the Fund can buy / sell unlimited quantities (or indeed any quantity) at that price? The answer is no. Each time money pours into the scheme, the fund has to buy shares and each time there are redemptions, the fund house has to sell. Apart from the brokerage costs and the Securities Transaction Taxes, the scheme also suffers from something called the impact cost. Here because of the funds buying the price moves up and because of its selling the price moves down. All of these costs are borne by the passive long term investors in the scheme while the entering and exiting unit holders in the scheme pay none of these costs. It is in order to level the field, EXIT loads are imposed on short term exits and ploughed back into the fund so that the scheme does not suffer.
In India, people willingly lock in money in PPF, Life Insurance Policies, Tax Free Bonds etc. The REITs which will be introduced will also be close end structures. However when it comes to Equities, easy come easy go is almost seen as a birth right. Equities are among the long gestation asset classes and one needs a long term view to come here.
Perma Bulls, Perma Bears, Perma Mutual Fund Thrashers
A lot of what is done by the Mutual Fund sector may be wrong. That needs to be criticized. However increasing EXIT loads on equity schemes is not one of those wrong measures. It is an honest attempt to inculcate the right behaviour through the means of incentives / penalties.