Tuesday, 23 November, 2010

Is zero exit load necessarily bad?

Is zero exit load necessarily bad?

Came across this post in one of my favourite blogs - The Parag Parikh blog.

First, read it, before I comment on the same.

From: PPFAS Blog
Sent: Monday, November 22, 2010 6:08 PM
Subject: PPFAS Blog: Zero Exit Load...A boon for speculators

November 22, 2010 4:01 pm
Jayant Pai | jayant@ppfas.com
I saw an advertisement on the Value Research website last week. It showed a family exulting in the fact that their child had secured "Zero" marks in the examination. The father was holding a placard stating that "Zero is the new Hero" and the mother was doing a jig. The ad screamed "Zero exit load on two of our flagship funds".
The ad could be considered hilarious, if it were not so depressing. What is the mutual fund trying to communicate? Equity mutual fund managers espouse the cause of long-term investing and the virtues of "time in the market rather than timing the market". Is such a development in sync with this belief? It will only encourage hot money to enter and exit at zero impact cost. It will also prevent the fund manager from taking a long-term view w.r.t. investments. For instance, in the normal course, a fund manager could have allocated 20-25% of the corpus to promising mid-cap and small-cap stocks which were relatively illiquid. That will now be virtually impossible as the sword of untimely redemptions will always be hanging over his/her head. Consequently the manager will play safe either by keeping aside large amounts of cash or investing in liquid stocks even if they are not the best choices at that mom! ent in time.
This appears to be a clear case of the fund's sales team triumphing over the investment team. Such moves to boost assets will be counter-productive in the longer term. Once a fund house becomes notorious as a channel for "hot money", investors with a longer-term outlook shy away from it, as it is well known that sharp ebbs and flows in assets in any scheme hurts the longer term investor more. When SEBI jettisoned the entry-load concept, most of the major fund houses increased the exit load. More than earning income, the objective was to discourage quick entry and exit. Unfortunately, the battle for survival amongst the smaller funds has induced them to opt for this "100% Free" route.
I hope this does not lead to a competitive free-for-all (no pun intended) amongst such funds, who will be competing against one another on price and not on investment performance. This will be detrimental for the whole industry and this time they will not be able to blame the Regulator for the same….

This is one of those rare occasions where I hesitate to agree whole-heartedly with the views expressed in Parag Parikh's blog.

My own thoughts would be, as usual, "It all depends on the context of the individual investor and the context".
  • Firstly, those investors who are long-term investors, the mere absence of an exit load would certainly not motivate them to redeem early.
  • Secondly, those investors who have a short-term mentality, will, in any case, redeem as and when they're comfortable booking profits. For such investors, "zero exit load" is indeed a boon.
  • Thirdly, we now have a situation where more and more fund houses offer a feature to invest / redeem through the stock exchanges. Here again, zero exit loads becomes an attractive proposition.
  • Periodically, we have huge volatility in the markets. At such times, an exit load would become a "mental block" potentially preventing investors from redeeming / booking profits despite being conscious of live dangers lurking around the corner, which could put significant downward pressure on the indices. In such times, a "zero exit load" adds significant value.

Having said all the above, there is indeed an element of truth that a "zero exit load" would, indeed, motivate people towards having a short-term orientation.

But then, whoever said that investing and building wealth is an easy task!!!



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