An Expense Ratio is an amount levied or charged, annually, by the Asset Management Company (AMC) or fund houses for managing the funds of an investor. Expense Ratio is also known as Annual Operating Expenses.
What are the main Components of Expense Ratio?
The expense ratio indicates how much an investor has to pay as a percentage of their investment to the AMC or the fund house every year to manage their money.
Suppose the expense ratio is 5% and your investment amount is Rs 10,000, then Rs 500 is what you have to pay to the company as the operating fee.
The main components of an Expense Ratio are:
- Management Fees (investment advisory fees)
- Administration Fees
- Advertising and Promotional Fees (12-1b Distribution Fees)
How is the Expense Ratio Calculated?
The expense ratio percentage depends on the size of the mutual fund i.e., different mutual funds will have different expense ratios, depending on the Assets Under Management (AUM).
The ratio can be calculated by dividing total expenses by total assets of the fund. Smaller the AUM, higher will be the expense ratio and vice-versa.
Also, every AMC or fund house publishes the expense ratios for all its mutual fund schemes on their websites, from time to time.
In India, the SEBI monitors the expense ratio charged by the AMC or the fund houses. As per the SEBI Mutual Fund Regulations, the maximum limit of the Total Expense Ratio (TER) of equity funds is 2.25%, whereas, in the case of a debt fund, it is 2%. In addition, SEBI has allowed mutual funds to charge up to 30 bps (basis points) more, if 30% or more of new inflows come from B15 cities. This is done in order to widen the reach of the mutual funds in tier – 2 and tier – 3 cities.
Is Expense Ratio Important?
Before investing in any fund, the expense ratio is something that an investor has to check.
The fund houses usually deduct expense ratios from the total returns generated by the fund, before giving it to the investors.
It is also important to note that regular mutual funds have a higher expense ratio than direct mutual funds. This is because in regular plans, in addition to other fees, the investor also has to pay brokerage fees whereas, in direct plans, there are no brokers involved. Hence, the expense ratio of regular plans will be higher and this will affect the returns from the fund.
So, as an investor, we must understand that the value of the expense ratio will affect the Net Value of Assets (NAV) and thereby the returns generated from a particular mutual fund. We must also keep in mind that a lower expense ratio does not necessarily indicate that it is a well- managed fund. A good fund would be the one that delivers a good return with minimal expenses.
