Why 'low cost' is not yet 'low cost'! - The Honest Truth By Ajit Dayal
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Investing in India - Honest Truth by Ajit Dayal
Why 'low cost' is not yet 'low cost'! A  A  A
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17 SEPTEMBER 2009


Quantum Long Term Equity Fund was launched in February 2006 as India's first direct to investor mutual fund product. The 1st calculation of the NAV of Quantum Long Term Equity Fund was March 13, 2006 (the Inception Date).

Not using distributors in an environment where every fund house did use distributors to "sell" their mutual funds to investors was heresy.

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We have often written about the fact that using a distributor or using a financial advisor is, per se, not a bad practice.

Our argument was on 2 fronts:

  1. all fees and incentives paid to the distribution channel should be disclosed. In the annual accounts of the Quantum Long Term Equity Fund (and other mutual funds) the fees of the asset management company, the custodian, the registrar, the accountants are all disclosed - why not that of the distribution channel? The disclosure of fees would allow the investor to see whether there was any link between the funds being recommended and the fees earned by the commission agents.
  2. Armed with information on fees paid for the commission agents (for filling in forms, collecting cheques, and giving advice), the investor could make a judgement call on whether the typical 2% to 6% fees that went out of the investor's pockets to the distribution channels was worth the advice and services received - or was there scope for improvement.
We wrote about this often not because we were against the distribution channels, but only because we wished there to be more transparency for the investors as they made decisions on how and where to invest their savings.

Of course, with the recent SEBI guidelines that prohibit all fund houses from paying commissions to distributors, what we practiced is no longer a heresy. It is a law.

The low cost option of Quantum Mutual Funds
Quantum Long Term Equity Fund was positioned as the Fund that will make more of your money work for you. Since there will be no distribution costs, more of your money will find its way to the investments for which the Fund was designed.

So, why does Quantum Tax Saving Fund - and its sister product, the Quantum Long Term Equity Fund - still have an expense ratio of 2.5% - at the top end of the allowed range (see Table 1)?

Table 1: Is Quantum a 'high cost' fund?
Peer Comparison of ELSS Funds source is www.PersonalFn.com
  1-Yr (%) 2-Yr (%) 3-Yr (%) 5-Yr (%) Risk (%) Risk-Adjusted Return Top 10 Stocks (%) Avg.Assets
(Rs m)
Expense Ratio (%)
Fund One 12.3 3.0 13.7 - 7.7 0.15 37.6 9,916.3 2.18
Fund Two -3.4 -6.5 13.1 22.2 9.5 0.13 36.2 4,620.4 2.34
Fund Three 7.4 -0.8 11.5 35.3 8.7 0.12 36.0 41,773.4 2.50
Fund Four 9.3 -5.0 9.6 20.8 10.2 0.11 42.0 8,963.9 2.29
Fund Five 0.8 -6.0 9.0 - 9.1 0.10 26.1 4,487.9 2.34
Source: www.PersonalFn.com

Note:
  1. Quantum Tax Saving has been in inception since December 2008, hence comparable data is not available
  2. NAV data as on Sept 4, 2009. Returns over 1-Yr are compounded annualised
  3. Risk and risk adjusted return ratios for the funds are taken over a 3-yr period
  4. Average AUM and Top 10 stock holdings are as on July 31, 2009
  5. Expense Ratio as on March 31, 2009
The above table came in via email from a reader.

"While Quantum is not mentioned here" said the puzzled reader, "the charges for Quantum TSF are 2.5 %. Why are your charges the highest in the industry? Given the fact that you do not pay commission / aggressively market the same the charges should be far lower."
(Note: Quantum was not mentioned in the original table because, as a matter of policy we don't let PersonalFn show any analysis on Quantum Funds. This is because I am a common founder shareholder in both entities. PersonalFn will not recommend any Quantum Fund to their clients, their clients have to ask for it - we wish to avoid any conflicts of interest. Also, the Quantum Tax Saving Fund was launched in December 2008 and does not have a long track record so it has no performance data to be included in the table).

The complaint is legitimate: if we have no distribution costs, why are our costs as a percentage of total assets we manage so high?

Is Quantum a high cost fund house?
Well, the answer lies in the fact that there are certain fixed costs and some variable costs for running a mutual fund.
There are fees to the registrar and transfer agents, lawyers, custodians, and the asset management fees.

As the assets increase, as the fund size increases, even though some of these costs may increase, they get spread over a larger asset base and the costs - when expressed as a percentage of total assets under management - start to decline.

So, with an asset base of Rs. 84 lakhs, the Quantum Tax Saving Fund has an expense ratio of 2.5% or about Rs 2.1 lakhs.

Two questions arise from this:
  1. can I make an estimate of what the Quantum Tax Saving Fund's costs would be if the total assets under management in the Fund were Rs 13,952 million or Rs 1,395.2 crore (this is the average size as measured by the assets under management of the five Funds listed in Table 1 above)
  2. If the other fund houses listed in Table 1 have expense ratios of 2.18% to 2.50% and if these include distribution commissions, what would the "true" costs have been if these fund houses did not have any distribution commission to pay?
Well, I cannot make a precise estimate of what the expense ratio of Quantum Tax Saving Fund would be if we had assets under management of Rs 41,773.4 million - or Rs 4,177.34 crore (as one of the existing funds has in Table 1 above).

But I can say this: our asset management fees (now at 1.25% and a part of the 2.50% expense ratio for the Quantum Tax Saving Fund) would definitely decline to about 1.01%

By law, we charge lower asset management fees as the funds under management increases.

So, if this lower asset management fee was the only benefit we could give you from size, the expense ratio would have declined from 2.5% to 2.25% - the second lowest number when compared to other Funds listed in Table 1 above. And if I could estimate some more economies of scale from a higher AuM, my costs may decline even further.

Table 2: What if Quantum Tax Saver Fund was a larger fund?
Maximum investment management fees, as prescribed by SEBI Assets under management If Quantum Tax Saver had Rs 4,177.34 crore, our fees would be....
1.25% Less than Rs 100 crore Rs 1.25 crore
1% Above Rs 100 crore Rs 40.77 crore
    Rs 42.02 crore
    1.01%

Strange, isn't it - even though many funds are much larger than Quantum Tax Saving Fund (one of them is 4,900 times the size of Quantum Tax Saving Fund), they don't seem to be enjoying any economies of scale.
Or, to put it another way, the investors in the largest Fund is paying the same expense ratio as investors in the much smaller Quantum Tax Saving Fund!

So, two conclusions from this:
  1. while Quantum Tax Saving Fund is indeed a 2.5% 'high cost' fund the fact that it has no distribution fees to pay means that it is geared to have lower costs as its size increase. But to see this built-in benefit, you need to invest in it and make the Fund larger! Just as, if you want a good political system, you need to vote in the good people as politicians. J

  2. maybe the real question should be, "how come other fund houses with larger funds still charge such high expense ratios? And how much of this is due to payments to the distribution channels?"
This note has focused on the expense ratios and not on the investment style or risks and returns associated with the different funds.
I have replicated the table as it came to me in the email from a reader, but I did add notes at the bottom. And I have deleted the names of the Fund houses.

What is true for Quantum Tax Saving Fund is true for all our funds, including the Quantum Long Term Equity Fund.
We are geared up as a low-cost fund house.
Though this will only be visible beyond a size.
But, boy, if we had Rs 41,773.4 million (Rs 4,177.34 crore) under management in the Quantum Tax Saving Fund, we would not be having an expense ratio of 2.5% - that is for sure!

Come, read the Offer Documents carefully, analyse the facts, and switch over to the Quantum Mutual Funds and enjoy the benefits of the low-cost structure that we have built.

Your larger investments in the Quantum Mutual Funds will benefit you!

Suggested allocation in Quantum Mutual Funds (after keeping safe money aside)
Quantum Long Term Equity Fund Quantum Gold Fund
(NSE symbol: QGOLDHALF)
Quantum Liquid Fund
Why you
should own
it:
An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation 80% 20% Keep aside money to meet your expenses for 6 months to 2 years

Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"


Note: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt Ltd and Quantum Asset Management Company Pvt Ltd.. Views expressed in this article are entirely those of the author and may not be regarded as views of the Quantum Mutual Fund or Quantum Asset Management Company Private Limited. To write to Ajit, please click here.


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9 Responses to "Why 'low cost' is not yet 'low cost'!"

Ajit Dayal

Sep 21, 2009

Dear Pratik:

A fund being well managed, with a low cost structure, and a disciplined sensible approach - all of these help investors in the Fund for sure - but do not guarantee the profitability of the Fund House for its shareholders and owners. Quantum Mutual Fund - in my very humble and biased opinion - is by far India's most investor-friendly fund. The proof is in the fact that we were THE ONLY fund house that stayed away from a distribution system that hurt investors even when it was legal to hurt investors! Having said that, we are doing well as a fund house thanks to the growing number of investors who recognise what we are doing.

Sir, please dont confuse the low cost fund with the running of the other businesses you mentioned.
MyMakaan was set up by another gentleman - the original founder - and then I invested in the company and backed him. He subsequently decided to do something else.

Quantum Securities is not linked to us in any way. In fact, as your comment confirms, it has confused people like you and we have already sought legal remedy for this. I have no idea what their current business status is.

PersonalFn did open many branches and then did close them down. But their service is good - you should try it! I hope they make money one day, as much as I am sure you wish for my sake that they do.

As an individual, I could possibly have been monetarily far richer than I ever will be doing what I am doing. Don't get me wrong, I would not like to be poor. But I would hate to lie and cheat and swindle you to get rich. There are many finance companies out there in the big and wonderful world, sir, who you probably rate as "successful". Best of luck to you in dealing with them.

You wrote very correctly: "Profts are not about wishful thinking they are about vision and ground work."
I think we have done all of that...but we changed the definition a bit by saying that "profits are also not about doing wrong things".

with regards,
Ajit

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pratik

Sep 20, 2009

can i know when you are low cost and well managed why so many companies started by you close down often? My Makaan Quantum Securities 7 branches of Personalfn, and some honest truths say quantum mutual fund may also, no doubt anything can happen, but your cannot be weak. Profits are not about wishful thinking they are about vision and ground work. i agree with high costs of large funds but small funds shouldn't have unnecessary costs, inspection of your cost will reveal how poorly managed they are and hence 2.5% is bad.

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Param

Sep 18, 2009

Ajit,
This is in addition to my comments earlier.
I believe the team that has provided you the expense ratio data for the fund with 4K Cr assets (which is SBI Magnum Taxgain, btw) is mistaken.
I went thru the latest factsheet to confirm my thought as something seemed fishy.
***Unable to post the link as it is not allowed.***
The expense ratio shown is 1.83%, which is in-line with the SEBI mandate I mentioned.
If the team used Value Research Online data (which shows 2.5% btw), shame on them!!!
You have a point, unfortunately it came out pretty bad.
Regards, Param

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Ajit Dayal

Sep 17, 2009

Mr. Sastri: You are correct. I should have said that fund houses are prohibited from paying commissions to distributors FROM THE MUTUAL FUNDS. Sure, fund houses can surrender all the management fees that they earn from managing money to distributors - and even more if they wish to. So, it was not a lie - and I seek your forgiveness for missing the 4 words above in CAPITALS.

The debate on how exit loads can be used is still going on. At Quantum Long Term Equity Fund, all the exit load ends up with the investors who stay on in the Fund. As soon as SEBI put a ban on entry payments, many fund houses increased their exit loads. SEBI made them role it back, from what I understand.
The spirit of SEBI's law is that investors must pay distributors and financial planners a direct fee - nothing should come from the mutual funds (yes, you are right that the FUND HOUSE can pay as much as it wants to). But let's await more clarifications and developments. Thank you for your comments. I stand corrected. Regards,

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P.S.SATHYAMURTHY

Sep 17, 2009

Dear Ajit,
My woe is I can't get QLTEF forms from Karvy also. They even said that quantum has merged with ING. I don't believe. Another point is that yr. transaction fees are high. Why transaction fee when I have already decided to invest in quantum funds?

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Gaurav

Sep 17, 2009

I appreciate the fact that you have answered my query.
Actually I did suspect that this was due to the small fund size, but I wanted to get this clarified.
Also we would like to know where Quantum stands amongst its peers. While your companies may not want to recommend Quantum group of Funds for conflict of Reason, the investors would like to see comparisons of Quantum with the peers (whenever a like minded MF is researched).

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Param

Sep 17, 2009

Ajit,
Though your staunch supporter, I agree with Rajendra. Funds can still pay upfront commissions (from AMC charges), trail commissions (charged to fund) & other commissions (from exit load collected upto 1%).
The other part is the numbers seem a bit puzzling. I do recall SEBI guidelines on total expense ratio as well as AMC fees. The regulations permit equity funds to charge 2.5 per cent for average daily net assets of up to Rs 100 crore, 2.25 per cent for the next Rs 300 crore and 2 per cent for the next Rs 300 crore. For the rest of the assets, the maximum limit is 1.75 per cent.
In this case, how is it possible for the fund with 4K cr assets to charge 2.5% - either I interpreted the rulebook wrong or you unearthed a scam for SEBI!!!
Regards, Param

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Rajendra Sastri

Sep 17, 2009

You say, "Of course, with the recent SEBI guidelines that prohibit all fund houses from paying commissions to distributors, what we practiced is no longer a heresy. It is a law." You lie, Mr. Ajit Dayal. You know very well that SEBI has only abolished the entry load. Please quote one sentence from SEBI's guidelines which says that fund houses are prohibited from paying commission.

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Carlon Iyengar

Sep 17, 2009

Hi,
Speaking of charges brought me to ask you a question. I've been investing for the last 3 years with your company via MF purchases based on recommendations from your team at PersonalFN. (Good chaps)
There's been a new fee structure proposed by your company.
Unfortunately I'm a small investor (hardly 1-2 lakhs annually). For my kind of investing mainly MF investments I believe that your company is proposing a Transactions fee. No problem with that. However it's fixed at 5000. Just wanted a clarity as there are some companies that are not charging anything. Am I missing something or am I intepreting the charges incorrectly.

Regards
Carlon

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