The pool of investments which is drawn from several investors – individual as well as institutional, is called mutual funds. A team of experts can manage and generate returns form mutual funds. Hence, the service involves some amount of charges or loads.
While selling mutual funds, sometimes you need to pay a small amount as a penalty to the Asset Management Companies (AMCs). This penalty is known as Exit Load. Most of the mutual funds impose penalties or exit loads. But some are still there, which do not impose any exit load. Let us make it very clear that a mutual fund without any sort of exit loads is always better than a mutual fund that imposes exit load. But if you think of the scheme’s pedigree, then it does not matter whether there is any imposition of exit load or not. Hence, it is essential to understand the reason for the existence of exit loads.
The reason for the imposition of Exit Loads:
Generally, the imposition of exit loads takes place to discourage premature withdrawals. Fund managers who are responsible for the schemes and look after all the matters want that their investors stay invested for a long period of tenures.
This is so because, in case of the exit of too many investors, the fund manager will land into trouble. He will have to sell shares in distress. These shares should be of those companies which are well managed but liquid. This will rob the existing investors of their future growth potential. This is the reason why mutual funds tend to impose a penalty or exit load for discouraging investors from moving out too early.
Different types of exit loads:
There are several types of penalties or exit loads. Let us have a look at all of them.
We often see that some funds have a flat exit load. On some other times, we come across funds that have a tiered structure. In case of a tiered structure, you have to pay a higher amount of exit loads if you wish to make early withdrawals. But, if you choose to stay invested for a longer period, then you need to pay a lower amount of exit loads. Gradually, it diminishes after some time.
It is important to understand that debt funds which follow a typical accrual strategy, impose a higher amount of exit loads. This is so because such funds always expect the patience of investors.
Let us consider the case of the Franklin India Credit Risk Fund. You need not worry if you withdraw just up to 10% of your units every year. There is no charge for this setup. But if you exceed this limit of 10%, then you will be charged 3% for withdrawals before the period of 12 months. The charge reduces further to 2% and 1% if you make withdrawals before 24 months and 36 months respectively. You need not pay any charge if you make withdrawals after 36 months. Generally, equity funds have an exit load with a validity of up to one year of your investment.
The machination details:
Before the year 2012, AMCs or Asset Management Companies utilized the collection of exit loads for sales and marketing activities. But if a large number of investors make premature withdrawals, then this may result in the loss of existing investors.
After 2012, the Securities and Exchange Board of India or SEBI, the regulator of the capital market, made amendments. According to SEBI, the exit loads must go back to the respective mutual fund schemes. The aim here is to protect the existing investors from the loss of premature withdrawals by others.
AMC incurred a huge loss because it was not allowed to pocket the exit loads. So, the Securities and Exchange Board of India permitted different fund houses to charge an extra 20 basis points to every scheme. But later on, in the year 2018, SEBI gave out orders that the AMCs have to push the expense and lower it from 20 basis points to 5 basis points. The reason behind this order is to reduce the cost of making investments in mutual funds.