Five things to know about expense ratios of mutual fund schemes

Five things to know about expense ratios of mutual fund schemes

Mutual funds acquire various costs to manage your money. These cover fund management, custodian, registrar & transfer agent costs, marketing expenses, commissions payable, and other recurring costs. The expenses under different heads are aggregated into a single figure and are required to the scheme as a percentage of the assets managed. This is termed as the total expense ratio of the system.

How much are MFs allowed to credit?

While the equity funds can carry up to 2.25 percent, non-equity schemes can charge up to 2 percent as a base price ratio. This expense ratio is to be brought down as assets under administration (AUM) increase, according to the slabs appointed by the Securities Exchange Board of India (SEBI). Exchange-traded funds filling in indices and gold cannot kevy more further than 1 percent as base TER. Fund of funds container charges more than 2.25 percent, including the expense ratio of the underlying equity schemes. In the case of fund of funds financing in bond funds, the TER cannot exceed 2 percent including the expense ratio of the underlying systems. Funds are also allowed to charge an additional 30 basis points towards costs if they get inflows from beyond the top 30 cities in India. Goods and services tax is required over the base expense ratio.

Other factors resting the same, a higher expense ratio means lower returns for investors.

The expense ratio is effective

TER is a number displayed as a percent of the daily assets of the scheme. It is made obtainable on the website of the mutual fund and also in the fact sheet. Fund houses can improve the expense ratio periodically. Many a time, fund houses offer a low-cost ratio to bring investors when the scheme is launched and the same is increasingly hiked within the limit prescribed by the SEBI after a track record is established.

When the expense ratio is raised, the same needs to be communicated to investors at least three days before such a difference, by sending an email or SMS.

Charges differ: Active vs Passive and Direct vs Regular

Regular plans of the mutual fund schemes are marketed by distributors and the TER of these schemes factors in the commission owed along with other expenses. The TER of a direct scheme does not have this commission element and hence charges a lower TER compared to a regular plan. If you are a ‘do it yourself investor’ and can determine the right schemes, then you can consider buying in direct plans.

Actively managed funds charge higher than passive schemes. Exchange-traded funds reflecting the widely followed index – Nifty 50 – charge as low as five support points.

Investors, however, should not apply all passively managed products with the same colour. ETFs tracking thematic indices may require more. 

Returns after rates matter

A few years ago, when the investors were hunting high yield credit risk funds, they ignored the high rates. It appeared in almost similar returns as compared to other low yield high-quality debt funds such as corporate bond funds and banking & PSU bond funds, which required much less.

For instance, if a bond fund has a portfolio yield of 5.5 percent and the expense ratio stands at 75 basis points, then the required return stands at (5.5 minuses 0.75) 4.75 per cent.

Fund houses have started multi-asset funds and other commingled funds that invest in multiple asset classes. In such circumstances, the TER of the scheme needs to be checked in the context of conventional returns. Debt oriented hybrid funds have become unattractive given their essential expenses and low expected returns.

When an investor knows the right asset allocation for him and has the system to stick to it, he should do so on his own by choosing the right mix of bond and equity schemes. This helps to save on costs, and boost profits,” says Rupesh Bhansali, head of mutual funds, GEPL Capital.

Expense ratio and investment arrangements

Though the expense ratio of a mutual fund system is important, it cannot be the sole foundation for choosing an investment. “What if you are on a fund charging low expense degree and it doesn’t deliver the desired outcome,” asks Ravi Kumar TV, author of Gaining Ground Investment Services. “Though the last few years have been exciting for many actively managed funds, they are supposed to come back in the current environment and investors will move back to actively survived funds soon. In addition to expense ratio, investors need to recognize other costs such as taxes,” he adds.

While assessing passively achieved funds, the expense ratio plays a crucial role. In debt funds, check for the fund manager’s capacity to manage both credit and interest rate risks, amongst other factors.