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B. Venkatesh

INVESTORS feel that mutual funds should not charge entry or exit loads. An exit load of 0.50 per cent on a net asset value (NAV) of Rs 10 means that you will receive only Rs 9.50 on redemption. Not charging entry or exit load may be detrimental to the unit-holders. Why?

Suppose a fund raises Rs 10,000 each from five investors and buys Infosys at Rs 2,500; the NAV is Rs 10 per unit. Now, the fund receives another Rs 50,000 from five more investors. It again buys Infosys at Rs 2,500 but incurs brokerage of 0.25 per cent.

The total assets will increase by only Rs 49,875 (Rs 2,500 times 20 less brokerage). The brokerage of Rs 125 will be divided among all unit-holders. Thus, the NAV of the fund will be Rs 9.98 (Rs 50,000 plus Rs 49,875 divided by Rs 10,000).

Notice that the NAV has dropped from Rs 10 to Rs 9.98 even though Infosys remained at Rs 2,500.

Each time the mutual fund gets money from unit-holders and buys stocks and bonds, it will incur brokerage. And that will reduce the NAV because the cost is borne by all unit-holders.

The same is the case when unit-holders exit the fund. Sometimes, the fund may sell stocks and bonds to meet redemption. The brokerage incurred will be borne by the existing unit-holders.

Now, suppose the fund charges an entry load of, say, 0.25 per cent. This charge will be used to pay the brokerage incurred for buying stocks and bonds with the inflows. The existing unit-holders will not, therefore, share the costs.

An exit load will similarly help pay brokerage incurred for selling the stocks and bonds to meet the redemption requirement. In short, not charging entry and exit load is not really good for you!

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