What is an exit load in mutual funds?

Patience is a key element in mutual fund investing. This is because mutual fund products, especially equity schemes, are largely created to cater to the investment goals of retail investors. The longer the wait, the better the prospects of making high or stable returns. 

However, some investors may want to redeem their funds within a short period for a variety of reasons, including in the event of an emergency. In such cases, mutual fund houses may charge investors a fee for redeeming their funds before a specified time from the allotment of the units of the scheme. This is done to protect the interests of long-term investors.

Can the exit load change?

The condition of charging an exit load is clearly defined in a scheme information document. A fund house can alter the exit load from time to time. The exit load applicable on the date of allotment of units is applicable to those specific units. 

To understand this better, here’s an example: 

An investor is allotted 1,000 units of a scheme. 

The scheme charges an exit load of 0.5% for any exits before completing 90 days from the date of allotment of these units. 

One week later, the asset management company changes the exit load to 1% for any exits before completing 90 days from the date of allotment of units. 

After that, the same investor puts more money into the scheme and is allotted 2,000 units.

In this case, the first 1,000 units will be subject to an exit load of 0.5% if sold before 90 days from the date of allotment and the second lot of 2,000 units will be subject to an exit load of 1% if sold before 90 days from the date of allotment.

How to calculate exit load?

Exit load is calculated using the net asset value (NAV) on the redemption date. 

Here's an example: 

An individual invested ₹1 lakh in a scheme at an NAV of ₹10. The investor is allotted 10,000 units. The exit load is 0.5% for exiting the scheme before completing 90 days from the date of allotment of units. This investor decided to sell after the end of two months when the NAV increased to ₹10.50. 

In this case, the exit load can be computed using below formula:

NAV at the time of exit X the number of units X by the exit load in %

10.5 x 10,000 x 0.5% = ₹525

The redemption proceeds will be calculated as below:

(NAV at the time of exit X by the number of units) - exit load

(10.5 x 10,000) - 525 = ₹104,475

An exit load can be of various types. Liquid funds charge graded exit loads as displayed below:

Typically, equity funds levy an exit load if units are sold before one year from the date of allotment. Steep exit loads are charged when a mutual fund house wants investors to remain invested in a fund for a stipulated period of time. Overnight funds and ultra-short duration funds generally do not charge exit loads. Other bond funds may have exit loads. However, the quantum of exit loads may vary from one fund house to another. Investors who invest in relatively illiquid bonds or focus on accrual income may have to pay an exit load. This is because the motive of fund houses is to discourage frequent churn.

Systematic transactions 

When you invest in a mutual fund scheme through a systematic investment plan (SIP), there is a series of purchase transactions. Each purchase transaction is considered a separate transaction. And each tranche of units is subject to exit load from the date of allotment. For example, an equity scheme charges an exit load of 1% if units are sold before completing one year from the date of allotment for SIP transactions. The first installment is done and units are allotted on 10th January 2021, the second installment is made on 10th February 2021 and so on. The units allotted in the first installment come out of the exit load period on 11th January 2022 and the units allotted in the second installment come out of the exit load period on 11th February 2022, and so on.

If you sign up for a systematic transfer plan (STP) and the units in the source scheme are subject to an exit load, then the exit load is charged. Each transfer or switch is a redemption and is treated accordingly. Similarly, each allotment of a unit in a target scheme is subject to exit load from the date of allotment.

Some fund houses provide trigger-based redemptions or switches. In such cases too, exit loads are charged wherever applicable. 

Here’s an example:

You invested in an equity fund that charges an exit load of 1% if units are redeemed within one year from the date of allotment. You have also signed up for a trigger-based redemption if the NAV moves up by 20%. Such a move happens within six months, and the fund house acts on your trigger request. The redemption request will be processed only after factoring in exit loads, since you are exiting before completing one year from the date of allotment of units.

Exit loads are defined on the basis of holding period. There is no connection with the profitability of the investment for you. An exit load is payable even if you are making a loss on your investments. Since the proceeds of redemption factor in exit loads payable, they are factored into the capital gain computation on the investment.

So the next time you choose to invest in a mutual fund scheme, remember to pay attention to the exit loads associated with the scheme before investing.