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How Entry and Exit loads affect you


Mutual funds sometimes charge you something to buy units from them, or sell them units. Charges on purchase are known as entry loads and charges on exit are called exit loads (or “contingent deferred sales charge (CDSC)” which is a glorified term for exit loads).

Entry loads for equity funds range from 0 (no load) to 2.5% of the value you purchase. Exit loads can very over time and typically range from 0% to 4%. Most closed ended funds launched recently have hefty exit loads to discourage early exits but these loads go down to zero after a while (2 years or such). Most open ended funds have no exit loads – only temporary exit loads.

Entry loads are used to pay distributor commissions. If your distributor is asking you to change funds often, he is trying to earn money from your entry loads. To avoid this, Quantum mutual fund was started by Ajit Dayal with the philosophy that distributors looting commissions from you is simply not right. Of course, his views are echoed in articles by PersonalFn (his own company), DNA India etc.

So Quantum AMC launched Quantum Long Term Equity fund, a fund with no entry load and which is not sold by distributors – instead, you have to contact the fund directly. Kinda like the Vanguard fund in the US which is very very popular.

But for some reason, Quantum charges ridiculous exit loads. From 4% in the first six months, to 0% after 2 years. Such loads are common where the fund manager wants you to stay with the fund, but I personally think anything beyond 1 year is unreasonable; if your fund does not do well after one year, you should be able to exit without penalty. Even capital gains tax only applies if you sell your shares within one year or holding!
Let us now see the effect of these loads on your shareholding. I will compare different kinds of funds for one year of holding:

1) Quantum Long Term Equity Fund – No entry load, 2% exit load after on year. Very new fund, but low assets of only 22 cr.
2) HDFC equity fund and Reliance Vision Fund – Large cap diversified funds, with 2.25% entry load. No exit load. Much more than five years old, so have no amortised costs.
3) SBI Bluechip fund and HSBC Advantage India Fund: New funds which have amortised initial expenses (read: more distributor commissions). Had no entry load during NFOs but this was bought POST their NFO, so 2.25% entry load applies. They have no exit load beyond 6 months.
4) NiftyBeES: An Exchange Traded Fund which invests in the Nifty stocks, and has no entry or exit loads. But you will face brokerage charges (usually 0.65% in total) that will act upon both entry and exit so I’ll consider that as your load instead.

Only growth option of funds are compared, with the exception of NiftyBeES which only has the dividend option (but I’ve added up the divident when comparing) Here are the results, purely on an NAV basis.

From the NAV it looks like HDFC fund has done excellently, but NiftyBeES has done phenomenally! Of course, none of these funds have done better than the Nifty (12.87% in one year). SBI Bluechip is actually negative for the year, even though bluechips have done well; I can attribute this to the high amortised costs.

Quantum Long Term Equity fund is not at all spectacular, but has done better than other funds launched around the same time.

Now, let’s put in the loads and make the comparison. Let’s assume you invested Rs. 10,000 last year, and see how much it has become with the entry and exit loads accounted for:

You can see here how load affects you:
1) If you don’t exit your investments, you will note that NiftyBeES is still the best fund to have (13.04%, considering a Rs. 8 per unit dividend in Jan 07). But the next best fund is Quantum long term equity fund (8.42%), purely because it charged no load.
2) If you choose to exit, then NiftyBeES stays superior (12.31%) but the next best fund is HDFC Equity (8.23%) purely because it charged no exit load! Quantum now slips to 6.25% gains only, which is all because of its very high exit load.

Frankly, the better performance of NiftyBeES is also due to the fact that it costs about 1% as annual charges, and the others listed charge 1.5%-2.5%. This is reflected in the NAV, which is lower.

All this proves a few things:
1) Zero entry loads does not mean the best return. After one year, even with a non-zero entry load, NiftyBeES has done better.
2) Zero exit loads also don’t mean a better return.
3) Investing in established actively managed funds may not be better than investing in a passive fund like NiftyBeES.
4) You can’t take loads in isolation – choose funds whose NET load (entry + exit) works out better for you.

This article may be invalid next year, when Quantum finishes two years of existence and therefore has 0% exit load – I will recompare then. But at this time, the best fund to go with is the NiftyBeES. No distributor will sell this fund: talk to your stock broker instead (it’s like a stock traded on the exchange).


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