High exit loads in Mutual Funds actually work for investors!

Here’s an analogy to start with:

Every time you travel across the city, you end up paying entry and exit fees at various tolls, isn’t it? And this can be quite exhausting really, so the next time while you’re waiting in the queue to pay your toll and fuming about the entire process, take a while to look around and notice how the roads that were once narrow and difficult to drive on, have been transformed (well almost) into extensive highway stretches, and how a drive, for instance, from Mumbai to Pune is no longer a drag but rather a windy highway to heaven.

Well, this is practically the same case with Mutual Funds. So, if you have always considered a high exit load as a deterrent to investing in any particular fund, here’s a view on how these exit charges in mutual funds endeavour to work to make you have a smooth and comfortable investing ride.

When you exit a fund before its minimum holding period and redeem your investment, you are charged a penalty known as “Exit load”. You can refer to this as a fee collected by a mutual fund to discourage short-term, in-and-out trading of mutual fund units.

This load is charged to you only if you leave the fund prematurely, and if collected, these redemption fees do not go to the asset management company, but are credited to the fund`s assets.

As per SEBI regulations, a mutual fund house can charge an exit load in the range of 0% to 7% on the total redeemable amount.

The story till date

A universal question asked by many investors – “Why does a mutual fund charge me high exit loads when the money actually belongs to me?” To give you a different perspective to mull over, we’re going to try to explain some reasons and benefits of a high exit load.

A mutual fund imposes the exit load so that you as a long term investor would not have to incur the consequence in case a few fellow investors decided to quit the fund before the lapse of the minimum stipulated holding period and redeem their share of the stocks.

Load charges help mutual fund companies to pay distributor commissions and towards marketing / selling expenses. However, in June 2009, The Securities and Exchange Board of India (SEBI) issued a regulation that instructed fund houses to reinvest a portion of the exit load charges back into the fund itself. Hence, today, mutual fund companies can use 1% of the load charges for its expenses such as commissions and marketing costs, while the rest of the amount needs to be pumped back into the existing scheme.

Interestingly, Quantum Mutual Fund has always faced multiple investor queries on why our exit loads are so high - 4% for redemptions within 6 months; 3% after 6 months and within 12 months, 2% after 12 and within 18 months, 1% after 18 and within 24 months, Nil after 24 months

It’s like 4 investors A, B, C and D who have invested into a fund. Now, one fine morning D figures that the time is just right and decides to leave the fund within 6 months of getting into it. D can walk away with his corpus, but, what happens to A, B and C? Are they unaffected? Not really!

Since D has decided to leave the fund, he needs to be paid his redemption proceeds which need to be arranged for by his fund manager.

The fund manager tries to arrange for this through the cash allocation, which is usually kept handy for such occasions. But, he realizes that the current cash allocation is insufficient to meet the redemption requirement. So what does he do now? He will have to sell stocks to generate the cash required. But are the valuations right to sell? Maybe, maybe not. But because of the redemption request, the fund manager is coerced into selling a stock that he might have wanted to hold on to for a little while longer.

Now, ofcourse this is a probability, but it is a very real and possible probability, wouldn’t you say? So, just because an investor chose to pick the quickest way out from the fund, why should the patient long term investor who continues to stay with the fund loose out on potential opportunity because the fund manager had to sell one of his better stocks.
And if this wasn’t enough, every time an investor redeems his holdings, the fund incurs expenses which in turn impact its net asset value (NAV). Frequent short term redemptions from the fund will keep adding to these expenses and eroding the NAV, which will only disappoint the long-term investor who has to deal with a fall in the NAV of his investments.

Equities and mutual funds are brilliant wealth creation tools; however they require discipline which demands a long term approach and commitment.

The Silver Lining

If investors look at the big picture, the announcement by mutual fund houses to increase the lock-in period of their schemes from 6 months - 1 year to 1– 3 years should be considered as a silver lining.

The main intention behind charging high exit load is to make sure that the fund appeals to investors who are looking at long term investments and discourage speculators who wish to make quick money in a short span.

When a fund witnesses huge outflows because of short term investors, it brings about a possibility of the fund underperforming as compared to its potential, which in turn would probably result in lower returns for the existing customers. Is this what you had planned while putting in your hard earned savings into a fund? Surely not.

A high exit load structure clearly differentiates between a balanced long term investor and a money scheming short term speculator.

Keep the long term investment in sight

As suggested by most financial stalwarts, it is best if you invest your money in long term funds since these are a sound investment option and also less speculative. Don’t let high exit loads of a fund deter you, instead they should put you at ease considering that such a fund has a focus on long term investments and is keen on safeguarding other investors from any financial harm incase a few members pull out of the fund.

Having said that, always focus on a fund that meets your investment objective and that understands your risk profile and capacity, more so in times like now when the investor is spoilt for choice in selecting the right mutual fund.

So, yes, Quantum levies high exit loads, and we believe that investing should always be for the long term, and we’ll go the whole mile to discourage short term speculators from entering our funds. And, since we are a direct-to-investor mutual fund, and have paid zero distributor commissions till date, all of the exit load proceeds that we earn from short term redemptions are plowed back into our funds, a practice we are following right from the date of inception of our funds.

We hope that exit loads stop deterring you from making the right choice for your investments; the long term perspective towards generating wealth out of your hard earned savings.

Above article is authored by Quantum.

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