Case 058AMC and distribution economicsCore
Shreyasi Mutual Fund's flagship equity fund grows from Rs 5,000 crore to Rs 25,000 crore. Using an illustrative slab schedule in which the expense ratio falls from 1.75% to about 1.25% as AUM grows (confirm the current SEBI slabs), how much do fees grow compared with AUM?
1The situation
Shreyasi Mutual Fund's flagship flexi cap fund has grown fast on strong performance, and the board is reviewing a five-year plan that assumes it reaches Rs 25,000 crore from Rs 5,000 crore today. The strategy team's draft multiplies today's fee revenue by five.
Expense ratios on equity schemes are capped by slab: each additional band of assets carries a lower maximum rate. For this exercise use an illustrative schedule, charged at the cap: 2.25% on the first Rs 1,000 crore, 1.625% on the next Rs 4,000 crore, 1.30% on the next Rs 5,000 crore and 1.05% on the next Rs 15,000 crore. The real SEBI slabs differ in detail and have been revised; confirm the current figures before using any of this.
2Your task
How much does fee revenue grow as the fund grows five times, why, and what should the board plan around instead of the draft?
Quick check
The fund grows five times. Roughly how much does its fee revenue grow under the slabs?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Fees grow about 3.5 times while assets grow five times, from Rs 87.5 crore to Rs 310.0 crore a year. Each new slab of assets is charged a lower rate, so the blended expense ratio falls from 1.75% to 1.24% and the next rupee earns only 1.05%. The slabs pass Rs 127.5 crore a year of scale benefit to investors, and the plan should model fees by slab.
Step 1How does a slab schedule work?
Think of income tax in reverse. A tax slab charges a higher rate on each extra rupee you earn; an expense ratio slab charges a lower rate on each extra rupee the fund manages. The rate on the last band applies only to the money in that band, so the blended expense ratio falls gradually as the fund grows. At Rs 5,000 crore, the fund earns 2.25% on Rs 1,000 crore and 1.625% on Rs 4,000 crore: Rs 22.5 crore plus Rs 65.0 crore, Rs 87.5 crore, which is exactly 1.75% of assets.
| 1,000; 4,000; 5,000; 15,000 | the width of each slab in Rs crore |
| 2.25% to 1.05% | the illustrative cap on each slab |
| 310.0 | fee revenue in Rs crore a year at Rs 25,000 crore |
Step 2How much slower do fees grow than assets?
At Rs 10,000 crore the fund earns Rs 152.5 crore, a blended 1.525%. At Rs 25,000 crore it earns Rs 310.0 crore, a blended 1.24%. Assets grow 5 times and fees grow 3.54 times, because the extra Rs 20,000 crore is charged an average of only 1.11%. The draft plan, which keeps 1.75% on everything, shows Rs 437.5 crore of fees. That overstates revenue by Rs 127.5 crore a year, about 41% of the real figure.
| Fund size, Rs crore | Blended expense ratio | Fee revenue, Rs crore | Rate on the next rupee |
|---|---|---|---|
| 5,000 | 1.750% | 87.5 | 1.300% |
| 10,000 | 1.525% | 152.5 | 1.050% |
| 15,000 | 1.367% | 205.0 | 1.050% |
| 25,000 | 1.240% | 310.0 | 1.050% |
Step 3Who gets the scale benefit, and what should the board plan around?
The investors. Running a Rs 25,000 crore fund does not cost five times as much as running a Rs 5,000 crore fund: the research team, the systems and the compliance staff are largely the same. The slab rule exists so that part of that saving reaches the investors as a lower expense ratio, rather than staying with the AMC as margin. Here it is worth Rs 127.5 crore a year to them at full size.
Three corrections for the board. Model fees by slab, not by multiplying today's revenue. Remember that the expense ratio also pays distributors' commission in the regular plan and some scheme costs, so the AMC keeps less than the headline figure, and a shift of investors to direct plans changes the mix again. And note the business point the slabs make: an AMC's revenue grows faster by adding new schemes, which start again at the top slab, than by growing one fund very large. That incentive is worth naming, because it is why fund houses launch so many schemes. The slab rates used here are illustrative; confirm the current SEBI schedule and whether it applies scheme by scheme.
Where candidates lose it
The common error is to apply the lowest slab rate to the whole fund, as if crossing Rs 10,000 crore drops the rate on every rupee. That understates fees badly. Each rate applies only to the assets inside its band.
The opposite error is the draft's: keeping today's expense ratio on all future assets. It overstates revenue by about a fifth at full size and makes every later profit plan look better than it will be.
What the interviewer asks next
- Why might an AMC prefer two Rs 12,500 crore funds to one Rs 25,000 crore fund, and is that good for investors?
- Half the fund's investors move to the direct plan. What happens to the AMC's net revenue?
- The fund charges below the cap to compete. How would you decide how far below?
Company names and figures are illustrative.