When a mutual fund levies a sales charge or commission, the fund is known as a load fund. The amount that the investor pays is known as the load. It is collected to cover the costs of the sales intermediary, such as financial planner, broker, or investment advisor. The charges account for the time they put into running the fund and their expertise in selecting an appropriate fund for the investor.
The load can be paid upfront at the time of purchase (front-end load) or can be paid when the shares are sold (back-end load) or as long as the fund is held by the investor (level-load). The details of the load structure have to be disclosed in the offer documents of the mutual fund. Investors should consider the cost of investing in the mutual fund while investing in a fund. It could affect the overall returns that an investor aims to derive from a mutual fund. The mutual funds cannot increase the exit load beyond the level mentioned in the offer document. Any change in the load will only apply to future investments made in the mutual fund and not the ongoing investments.
Types of Loads in Mutual Funds:
Entry Load is a charge or a commission levied on the investor when the initial investment purchase within the fund. These types of funds are also known as Front End Load Funds. The entry load is generally deducted from the investment amount, reducing the overall quantum of investment. Generally, the entry loads are levied to cover the distribution costs of the funds. For example, suppose an investor invests INR 100 in a mutual fund with a 2% entry load. In that case, only INR 98 will be invested in the fund, while the remaining proceeds will move to mutual funds as sales charges or commissions.
In India, until 2009, an entry load of up to 2.25% of the total value of the investment was charged. It has been banned since then, which has negatively affected the mutual fund industry.
Exit Loads are charges that the mutual fund levy at the time of the sale of the investments of an investor from the funds. The commission is a percentage of the share’s value that has been sold. The exit load is not considered to be a part of the scheme’s earning. These types of funds are also known as Bank End Load Funds.
Suppose an investor invests in a fund that has an exit load of 1%. If total investments at the time of sale in the mutual fund are about INR 1 lakh, then an investor would have to pay INR 1000 as an exit load to the mutual fund. The exit load is reduced from the investment corpus, and the balance amount will be returned to the investors. In the example mentioned above, INR 99,000 gets returned to the investor upon selling his shares in the mutual fund.
Contingent Deferred Sales Charge or CDSC:
Suppose investments in the mutual fund scheme are for a longer-term horizon. In that case, a reduced exit load is levied on the investor. The investor is liable to pay a hefty exit load if an early exit is made from the fund. This type of exit load is levied upon the investor following the investment horizon. Suppose the exit load for an investor with a 15 years investment horizon is 1%, and he plans to exit the fund after five years itself. The exit load that will be levied would be 2.5%. The main aim of keeping heavier exit loads for a shorter term is to discourage the investor from making untimely exits from the mutual funds.
Load Funds vs. No-Load Funds
Certain funds are available in the market that do not levy additional costs or charges to the investors. These funds are known as no-load funds. These funds might not charge entry or exit loads but make that up by charging other fees. The no-load funds also have certain limitations on the redemption of the shares. The shares of a no-load fund can only be redeemed after a specified period. If an investor redeems his investment earlier than the specified period, an additional charge is levied.
While it may seem that no-load funds are much better investment options than a load fund, the commission paid to the financial intermediary would assist the investor in making optimal investment decisions to select the mutual funds they would want to invest in. The exit loads also align an investor’s goal to a longer-term horizon, which gives leverage and comfort to the fund managers as they can align their stock picks and strategies over a longer-term horizon.
Summing it Up
Before initiating an investment, an investor must consider the loads as they can affect the overall returns in a significant way. Suppose a mutual fund has consistently outperformed the market and provided handsome returns to its investors. In that case, the load costs should not be much of a consideration for the investor. However, the fund’s performance is also an essential parameter while considering the above.
Loads are just one of the various aspects that investors should consider aspects before purchasing any mutual fund. The investors who mainly invest for the long term should consider other costs like management fees, potential returns, investment goals, and time horizon before investing in the mutual funds. The investors are also not affected by any changes in the load charges incorporated by the mutual fund. They should read the prospectus in detail to understand the overall charges levied upon an investor during the mutual fund.