In today’s Finshots, we break down the SEBI consultation paper on mutual funds asset management charges.

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The Story

Over ten years ago, mutual funds were something we or our parents heard about over TV ads, that ended with the note, “Mutual funds are subject to market risks….” But today, they’re a part of almost every investor’s life. If you’re reading this right now, there’s a good chance that you or a friend, relative or colleague has invested in one. The industry scaled up like something never seen before, with assets under management (AUM) growing nearly from approximately ₹12 lakh crore to over ₹75 lakh crore in ten years. That means you’ve contributed to an industry that’s grown more than sixfold in just over a decade.

There are over 25 crore accounts today, which basically means that mutual funds are the go-to investment choice of everyday Indians. The industry scaled up like something never seen before, and the asset management companies (AMCs) were more than happy to take your money and invest it for you.

A big reason behind this rise was regulatory support. Back in 2012, SEBI brought in some measures to uplift the entire mutual fund industry. It wanted more investors, wider reach, and a revival of the industry after the 2008 financial crisis. To achieve that, it offered cost advantages to AMCs, allowing them to charge a slightly higher Total Expense Ratio (TER) for investments coming from beyond the top 15 cities.

Sidenote: Total Expense Ratio is the total costs tied to running and managing a mutual fund. It’s a fee that the fund house charges you for managing your money.

This incentive pushed fund houses to expand distribution deeper into the country. If enough money flowed in from smaller towns and cities, AMCs could raise their expense ratio by 30 basis points (0.3%). Distributors also benefited from the move. They were given a simpler NISM certification, making it easier to onboard and train new agents.

Over time, as AMCs and their funds grew in size, so did their overall costs.

Plus, SEBI allowed AMCs to levy a few additional charges, such as GST, brokerage and transaction fees, and exit-load fees (which is simply a fee you pay when you redeem your mutual fund investment sooner than expected). Now if you’re wondering why brokerage was kept separate from the TER, it’s because both brokerage and transaction costs are variable, and they vary based on actual trading activity of the fund, whereas the TER is supposed to give a more balanced and reliable number for true costs. This means whether or not the fund bought and sold stocks, it still needed money to pay salaries and staff costs.

Now the rules that SEBI had laid out were simple: keep the TER below a certain percentage, which varied based on the size of AUM for the fund houses.

And they did just that. If the TER limit set by SEBI was between 1% and 2.25%, fund houses usually kept their base expenses within those limits. As a result, the total cost that investors actually paid was often higher than the stated TER. And since many of these charges were disclosed separately, it was difficult for investors to know the full cumulative cost of their investment.

What’s more is when SEBI did research on the cost difference, the true costs of the funds were much higher, and some of the rules and regulations were in place since 1996 and unchanged since then. In those 29 years, the mutual fund industry grew multiple times, making some rules more or less obsolete and outdated today. For example, AMCs had to submit advertisements to SEBI 7 days before they went public, a requirement that's now handled digitally rather than through physical copies.

That’s why, in a recent consultation paper released on October 28th, SEBI proposed a sweeping set of changes, starting with how expenses are charged on mutual funds.

First up is the exit load. Before 2012, the exit load was also used by AMCs to pay distributors and cover marketing or selling costs. Under the new draft, that flexibility has been removed, though SEBI has added the exit load back for the first two slabs of open-ended schemes.  Think of these slabs as size buckets. The first slab is for funds managing up to ₹500 crore, and the second slab for those from ₹500 crore to just below ₹2,000 crore. These buckets decide the expense limits (TER caps) that funds have to follow.

A few years later, in 2018, SEBI trimmed the extra charge on exit-load for such schemes from 0.2% to just 0.05%. This better matched the actual exit load amounts received.

But now, SEBI wants to scrap this add-on altogether, except for those same first two slabs of open-ended active funds, where it’s allowing a small 0.05% bump in their expense limit to make up for it.

Then come the brokerage costs, which have seen a massive cut. Previously, AMCs could charge 12 bps for cash market trades and 5 bps for derivatives. That’s now been slashed to 2 bps and 1 bps, respectively, or an 80% reduction. Even if actual costs rise, fund houses will now have to absorb them within their overall TER.

But wait, why limit it? Isn’t brokerage a basic transaction cost? Well, yes and no. The discovery came about when they saw fees on arbitrage funds. These funds make money on a simple concept. If a stock is priced slightly differently on two exchanges or between the cash and futures markets, the fund buys at the lower price and sells at the higher one — pocketing the difference and making a profit.

SEBI found that arbitrage funds had much lower brokerage costs (1.18-1.34 bps) compared to other equity schemes (5-12 bps), sometimes differing by up to 11 bps. And it believes these higher costs in equity schemes likely include services beyond simple trade execution, such as research or advisory fees. Which effectively means some investors were being double charged: once under management and advisory fees and another time under brokerage and transaction costs.

Building on that, SEBI now wants to simplify and modernise how these costs are presented. Instead of clubbing everything under a single percentage, the new draft proposes a clear breakdown of all expenses. This includes separate disclosures for statutory charges like GST, STT, stamp duty, and CTT, so investors can finally see how much of their money goes where.

In fact, the definition of TER itself is now much clearer. It will include brokerage, exchange fees, regulatory fees, and statutory levies, and AMCs must disclose the full breakdown of these expenses to investors.

And here’s something new — SEBI has formally proposed an optional performance-linked TER framework. This means AMCs can choose to vary their fees based on how well a fund performs relative to its benchmark. If it outperforms, they can charge more; if it underperforms, they’ll have to charge less. It’s not mandatory yet, but SEBI wants to test if this makes fund costs more merit-based and investor-friendly. Because remember, this is still a draft paper and they’re open to public feedback till November 17th this year.

For investors, this overhaul could mean greater transparency and fewer hidden mutual fund costs. You’ll finally know where every invested and earned rupee goes towards your AMC.

But for the AMCs, it’s a mixed bag. The compliance burden may ease, but the cost-cutting rules around brokerage and TER could compress margins, unless some costs are passed onto mutual fund distributors.

And for SEBI, this is about future-proofing by updating a nearly 30-year-old rulebook to fit a mutual fund industry.

Until then…

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