Mutual fund exit loads are back. They are back to a certain extent in actual funds, but far more than that, they are back as a topic of discussion within the industry. The discussions are mostly about how exit loads are a desirable feature in many types of mutual funds, but how they won’t actually get implemented because investors dislike them.

Actually, I’ll try and show that investors should prefer funds with exit loads because they can ensure that precipitate actions of some other investors in a fund are much less likely to harm them. First, let’s see what an exit load is. Exit load is a deduction from your investment that is made when you redeem your money. Actually, the correct technical term for this kind of charge is ‘contingent deferred sales load’ (CDSC). It is sort of a deferred entry load whose levying is contingent upon an investor exiting a fund too quickly.

To understand exit loads, investors should understand what they are for. A fund company keeps a part of the exit load to pay for marketing and related expenses. The logic is that the fund company has incurred a certain cost in initiating an investment. However, this cost will be broken even and then some money made only after a specific period. If the investor quits too early, then the fund company must recover the cost. Beyond the fund’s expenses, the rest goes into the fund itself. That is, the money is added to the assets belonging to the existing investors of the scheme.

According to the new regulations of Securities and Exchange Board of India (Sebi), the fund company can use up to one per cent of the exit load for its own sales expenses. Any load charged over and above this will have to be added to the assets of the fund itself. The logic behind handing over this money to the remaining investors is that the exit of any investor harms the remaining investments and this is compensation for it.

Over the past year, a few changes have taken place (or are in the process of taking place) that have made it imperative for fund companies to start charging load. In equity, the abolition of entry load has meant that investors must stay for a reasonably long term for the business to make sense. Many fund houses have already effected these loads.

However, the real struggle is with exit loads in short-term debt funds. Sebi is in the process of making changes to these funds (which are used mostly by companies) that make it a problem if investors exit too early. Do note that too early in these funds means a matter of days. When a large investment flows out of such a fund, it causes problems in running the fund besides resulting in possibly slightly lower returns for other investors.

The ideal solution is to impose an exit load for investments withdrawn within a fortnight or so. However, no one in the fund industry seems to think it will work. Investors in these funds are CFOs of companies who are much more hands-on than individual equity investors. These professional investors may simply not accept an exit load and the result will be that they will only choose those funds that are exit load free.

I don’t know whether these investors will ever abandon their straight line thinking, but the logic of exit loads is very simple. If the exit load will apply to periods that are much shorter than your planned investment, then it actually makes your money safer.

(Dhirendra Kumar is CEO of Value Research India. His column

appears every Monday)