IPL just concluded and mutual fund lovers must have noticed the advertisement campaign of “Mutual Fund Sahi Hai”. Do you wonder who pays for these advertisements? IPL is a costly medium to display your product. Well, the answer is YOU PAY for these. Surprised? But this is the outcome of a game called “expenses ratio” in mutual funds. Let’s see details on the cost of investing in MFs – Expense Ratio.

Mutual fund investors full-time focus is on ‘returns’. They do not consider the impact of cost and its correlation to returns. Expense ratio decides this cost.

The expense ratio is as important as returns in a mutual fund, for the simple fact that higher expenses can eat your share of returns over the long run.

Also, expense ratio is a factor you can have a control over. You cannot control markets, but you can choose a fund from various funds with different expense ratio.

What is Expense Ratio of a Mutual Fund?

If you want to learn what constitutes expense ratio, the ways to understand is breaking them in the various heads.

A mutual fund typically has two types of expenses:

• One is non-recurring expenses that are incurred during the launch of a fund. These are amortized in parts (in a number of years in equal parts). These expenses are borne by the fund house and not charged to the investors.
• The second type is recurring expenses-fees and expenses charged for managing the scheme. It includes Fund Management (investment management), adviser’s fees (Brokerage to the distributor), trustee fee, and marketing & selling expenses.

These expenses are calculated from the daily average net assets of the fund. So if a fund is charging 2%, it means every day, fees equivalent to 2% divided by Number of Working Days will be reduced from NAV.

The NAV of each day (working) is actually calculated after accounting for expenses and hence, borne by the investors.

What SEBI says on Expense Ratio

Under the existing norms prescribed by SEBI, mutual funds are allowed to charge a maximum recurring expense or total expenses ratio (TER) as mentioned in this table:

SEBI guidelines further specify the limits of TER based on the size of the corpus.

But some funds especially small-cap funds or sectoral funds have expenses more than 2.5%. Why?

This is because, an additional 30 basis points (1%=100 Basis Points or BPS) can be charged by the mutual fund the top 30 cities, another 20 basis on other permissible expenses. So with all conditions met the expenses ratio can be as high as 3%!

Buck does not stop here. The MFs can also charge for the service tax on the management fee. Hence an equity fund with a corpus up to 100 crores may charge an expense ratio up to 3.3% !!!

What if your fund’s expense ratio is more

While the higher expense ratio in some cases can be because of the lower corpus (less than 100 Cr).

Investors should be cautious while investing in close-ended funds. Many of them charge relatively higher expense ratios than their open-ended counterparts due to high amortization rates & brokerage.

Option – Go for Direct Mutual Funds

It is mandatory for a mutual fund to launch ‘direct’ options. Since there are no commissions to be paid to intermediaries under this route, the expense ratios of direct plans are notably lower than of ‘regular’ plans.

Investors can opt for direct plans. If they want advisory, they can opt for Financial Planner or Advisors who charge fees. Even after fees, you can save a lot of money as compared to “Regular Plans”.

Before I end, please make a note that the expense ratio should not be your only criteria for choosing a mutual fund. Many other factors like consistent returns or management behind the funds are reasons critical to achieving your long-term financial goal.

Hope now the expense ratio and its components are clear to the readers. If you have any questions you may send me through the comments section below.

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