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The Asset Management Companies charge a certain percentage of fees to managing your Mutual Funds. This forms the total expenses that the investors must bear. The fund house charges investors for managing the fund, maintaining the portfolio, and making crucial decisions regarding the investment. Apart from this, the Asset Management Companies also charge fees for running the fund, promoting it and distributing it.
All these expenses collectively form the Total Expense Ratio of the Mutual Fund (TER). It is also known as the Annual Fund Operating Expenses.
You can find ‘TER of MF Scheme’ on the left side of the home page of the Association of Mutual Funds of India (AMFI) website (www.amfiindia.com). You can get information about all fund houses from this. The TER of each scheme can also be seen on the offer document of the particular scheme.
About Mutual Fund Fees
TER is a ratio, hence its calculation will include one or more component. Total Expense Ratio is nothing but a percentage of your investment that you pay a fund each year to manage your money. For example, if you invest Rs 10,000 in a fund and the expense ratio is 2%, you are paying the fund Rs 200 annually to manage your investment. TER is calculated by dividing the sum total of all expenses related to the fund by the fund's total investment.
Expense Ratio comprises of various charges and fees that is required for the day-to-day administration of the fund. This is the cost that is recovered from the investors on a daily basis, however it is disclosed once in 6 months only. There are three main components of the Expense Ratio:
(1) Management Fees
This forms the major bulk of the expense ratio. Mutual Funds are highly specialised products which require high level of professional investment management. This calls for in depth knowledge of the markets and assets, formation of strategies that exceed the benchmark returns. Fund Houses rope in talented and highly educated and experienced Fund Managers for managing Mutual Fund schemes. These Fund Managers are also compensated handsomely for this job. Hence, the advisory expenses are passed on to the investors. Usually, this comprises 0.5% to 1% of the fund’s assets.
(2) Administrative Costs
These are the expenses for running the fund on a daily basis. These expenses include email and other communication expenses, printing costs, record maintenance, customer service, and ancillary things. These costs vary from fund to fund.
(3) Distribution Fees
The 12-1b distribution fee is collected towards advertisement and promotion of the fund. Mutual Funds are distributed through various channels and intermediaries.
Apart from this there are also other expenses associated with the Mutual Funds:
Entry Load: This was charged at the time of investing in a mutual fund scheme. This amount was deducted from the Net Asset Value (NAV). Different fund houses charge different entry load fees. Generally, the charges were 2.25% of the investment value. However, the SEBI mandated that charging entry load was discontinued.
Transaction Charges: A nominal amount charged to investors only once during lifetime of the investment. AMCs are permitted to charge new a transaction fee of Rs. 150 for new investors and Rs. 100 for existing investors, on investments worth Rs. 10,000 and above. However, if the investment is worth less than Rs. 10,000, then no transaction fees is levied. In respect of SIP, a TC of Rs. 100/- is payable in 4 equal instalments, beginning from the 2nd to the 5th instalment, in case the total commitment towards SIP is for Rs.10000/- or above. You can check the transaction amount in your statement of accounts.
Exit Load: If you sell your mutual fund scheme within a short span of holding time, you have to pay an exit load. This is also known as the Redemption fees. This fee is levied in order to dissuade investors from exiting the scheme and to put a cap on the number of withdrawals. The exit fee is usually a percentage of the Net Asset Value (NAV) of the mutual fund held by investors. Hence, while choosing a plan, it is important to consider the exit load too along with its expense ratio. Exit fee is not however a part of your expense ratio.
Till September 2018, all equity funds are allowed to charge a maximum of 2.5% total expense ratio (TER) and all debt funds a TER of 2.25%. Along with this, the capital market regulator, Securities and Exchange Board of India (SEBI) allows all funds to charge 30 basis points more as an incentive to reach smaller towns and an additional 20 basis points as exit load charges.
However, recently the rules have changed. On 18 September 2018, SEBI reduced the upper limit of expense ratio for all open-ended equity-oriented funds. The expense ratio of 1.05% maximum can be charged for equity funds with AUM greater than Rs 50,000 crore. Fund houses operating with lower AUM are allowed to levy a little higher expense ratio according to the slab. Also, the expense ratio of index funds and exchange traded funds (ETFs) has been capped at 1%. So, the bottom line is, the range of expense has been lowered from 1.75%-2.5% to 1.05%-2.25%.
These measures have been taken by the SEBI in order to facilitate investors to earn a better rate of return and loose it owing to the high expense ratio. The SEBI also mandates that as the asset size of the Fund House grows, it is expected to charge lower expense ratio in a move to pass on the benefits of economies of scale to the investors.
In another important step, SEBI has scrapped the practise to charge upfront commission. Earlier, upfront commission was paid to the distributor at the time of investment. This was followed by trail commission for the entire duration of the fund investment. Now, the fund houses would follow only the full trail commission method to remunerate the distributors. This has been done to make the whole structure more transparent and profitable to the investors.
1. If the fund has an asset base of Rs 20 Lakh and the total fees is Rs 10 thousand in from the fund holders, then the expense ratio is 0.5%.
2. Total Assets of Mutual Funds X = Rs 2 Crore
Administrative expenses = 2 Lakh
Other Expenses = 40 Thousand
Hence, total expense = 2.40 lakhs
Expense ratio = Total Expenses/Total Assets
= 2.40 lakh /2 crore
It is evident that higher expense ratio shrinks returns. This is one of the biggest impacts of expense ratio on fund returns. If a fund’s return is 12% and the expense ratio is 2%, then the net return of a fund will be 10%. On the other hand, if the expense ratio of the fund is 3%, then the returns will be 9%.
However, we cannot just deduce in the absolute sense that expense ratio shrinks returns of all funds. The kind of funds and the way it is managed also determines how the expense ratio will impact the returns on the fund. Sometimes in an aggressively managed funds, the superlative returns negate the impact of expense ratio.
Experts say that the Total Expense ratio depends on various factors like the regulations laid by the SBI, complexity and nature of the product, as well as the competitive factors.
Most of the equity funds have high expense ratio because they are always actively managed funds. Amongst debt funds, short-term bond funds, duration or accrual strategy funds as well as ultra-short-term funds, the expense ratio is generally higher. This is because of the mode of the Fund Management. A lot of planning goes into choosing the right asset and constructing the portfolio, deciding the structure of the securities, the requirement of the collateral etc.
Hence, an expense ratio is not always bad and needs to be analysed in a relative sense rather than absolute sense. In terms of importance, it comes after the fund house’s lineage, the size of the scheme, asset base, performance and track record of the fund manager and so on. If the returns of your fund directly depends upon the strategies of the Fund Manager, then as an investor, a higher expense ratio should not be a deterrent for you.
Large Cap & Mid Cap Equity Funds
1) What is an expense ratio?
An expense ratio is the Total Expenses pertaining to a particular fund expressed in relation to the total money invested or asset base of the scheme.
2) Where can I find information on the expense ratio?
You can see on the left side of the home page of the Association of Mutual Funds of India (AMFI) website as well as the offer document for the scheme.
3) What are the new rules on expense ratio as per SEBI?
As per the new rules by SEBI effective 18th September, 2018, all equity funds are allowed to charge a maximum of 2.5% total expense ratio (TER) and all debt funds a TER of 2.25%.
4) What are the fees not included in the expense ratio?
Entry load (scrapped), Exit Load and Transaction fees are the three items which do not form a part of the Mutual fund fees
5) How does Mutual Fund expenses impact the return?
The expenses related to mutual fund reduce the actual returns, however, if the fund demands aggressive strategizing and management, the impact of expense ratio is negated by higher returns.
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