What is entry load and exit load in Mutual Funds?

In the last few years, mutual fund inflows into Indian markets have seen record peaks. As the number of investors grows significantly, we can consider what an entry and exit load entails in a mutual fund and the discrepancy between the entry and exit load of a mutual fund scheme.

One of the integral charges associated with mutual fund investments is entry and exit-load. In addition to the costs associated with the issuing of mutual funds, a variety of administrative, operating, and delivery expenses are borne by mutual fund organizations, which are typically passed on to investors in the form of loads. Simply put, it is the commission charged by asset management companies for investing in the various mutual fund schemes offered by the Asset Management Companies.

What is entry load?

Mutual fund firms used to charge a sum from investors as enter a scheme. This fee is referred to as a “load” in general. It may be assumed that the entry load is the volume or cost paid by an investor when entering a system or joining the business as an investor. An entry load is usually obtained to meet the company’s delivery expenses. As an entry load, various mutual fund houses charge various rates.

This fee was normally around 2.25% of the amount of investment in India. But after August 2009, SEBI discontinued charging the entry load for mutual fund investments

What is exit load? What is the purpose of this exit load?

When Asset Management Companies (AMCs) impose the price on investors at the time of exit or redemption of the mutual fund units held by them, it is called an exit load. If an investor leaves the fund within the stipulated period, for example 1 year in case of open-ended equity mutual funds excluding ELSS, he ends up paying the exit charge. Thus, when an exit from a mutual fund scheme is made by the investor, the returns earned by the investor is decreased as the proportion of the exit load is reduced from the NAV.

In the case of open-ended funds, participants have the opportunity as and when they choose to quit the system. Investors often refuse to remain committed for the specified amount of time for which they chose to invest in a portfolio. An exit load thus frightens the investors from leaving the funds prematurely. The number of withdrawals from the mutual fund scheme can also be limited by this charge. Hence the fund managers will be in a better position of managing the funds and take investment decisions without the disruption of frequent redemptions. The investors are also benefitted as they keep their investment untouched and let the money grow because long term investment is well supported by the rupee cost averaging and the power of compounding.

In general, the exit load in mutual funds is a percentage of the Net Asset Value (NAV) of the mutual fund. The Net Asset Value is calculated by the formula (Total asset – total liabilities)/ total outstanding shares. In most cases, from the Total Net Asset Value, the Asset Management Companies deduct the exit load. The remaining amount is credited to the account of the investors during redemption process. To know more about the NAV, please click the link: https://sipfund.com/blog/Net-Asset-Value-of-Mutual-Funds.html

Demonstration of exit load calculation

Let us talk about an example to understand the exit load calculation

Let us assume an investor invested ₹ 1,00,000 in an equity mutual fund scheme.

In scenario 1, investor gets the full redemption proceed into his account as the exit load was not applied. However, in scenario 2, investor must pay an exit load of 1% (₹ 750) which is deducted from the total redemption proceeds and the balance amount is being paid to the investor.

Exit Loads for different types of mutual fund schemes

Mutual fund houses charge the exit load on equity, hybrid and debt funds. However, some types of debt funds, such as the overnight fund and certain ultra-short-term funds, do not charge exit load from the investors. Among debt funds, apart from overnight and ultra-short-term funds, many schemes do not charge any exit load for some forms of debt funds, such as bank and PSU funds, Gilt funds, etc., Debt funds that adopt an accrual-based investing approach typically incur higher exit loads and they want investors to stay committed till maturity and minimize interest rate risk.

Mutual funds typically incur higher exit loads in equity funds than in debt funds since equity funds are designed for long-term investment tenures. Mostly aggressively controlled equity funds are charged with exit loads. However, many index funds do not incur any exit costs. If you choose to invest in equity funds to escape exit loads, you may even invest in Exchange Traded Funds (ETFs) that do not incur any exit loads. Whether or not you wish to invest in a zero-exit load fund, you should still note that equity funds are designed for long-term investment tenures and exit load should not influence your decision to select a specific fund.

Hybrid funds, like arbitrage funds, charge exit loads for early redemption. Many investors have the illusion that arbitrage funds are designed for very brief durations, such as overnight funds, and that there is no exit load. The truth is that most arbitrage funds bill the exit load for redemption within 15–30 days. You can also have an investment tenure of one month or more for arbitrage funds.

Why Take loads seriously?

When making an investment, investors must consider loads as it greatly impacts the return on their investment. However, when doing so, the performance of the mutual fund should also be kept in mind. This is because certain good-performing funds can have higher load costs, but they often produce higher returns.

A non-load fund enables the investors to enter or exit a scheme/fund without any direct costs for the acquisition or selling of units. From a regulatory point of view, the load cannot be raised by the mutual fund above a certain limit as specified in the document on the scheme. Any adjustment in loads would apply to prospective investments and not to current ones. The mutual funds can make changes to their offer document in the event of an adjustment in the load charge so that new investors can be well updated. As per the guidelines of the Securities and Exchange Board of India, no entry charges can be imposed on applications submitted directly to Asset Management Companies via the Internet or by designated collection centres.

Conclusion

Exit loads can be avoided if the investor systematically plans to sell the units. If investments are made by systematic investment plans (SIPs) in equity mutual fund, the investor may opt to sell only the number of units acquired more than a year ago which means he can choose to sell load free units. So, if an investor has 1,000 units and 600 units were acquired more than a year ago, only 600 units should be sold in order to avoid paying the exit load.