Total Expense Ratio (TER) In Mutual Funds: Calculation And Its Impact On Returns

Mutual funds

A fee is imposed for funds actively managed by fund managers. The fees include commission, promotion dues, fund management costs, etc. Total Expense Ratio (TER) in mutual funds is the combination of all fees related to actively managed funds. It is stated as a percentage of the Assets Under Management (AUM). Understanding TER will help investors manage their returns and invest in funds wisely. Give this article a read to get all the information on the Total Expense Ratio. 

What is the Total Expense Ratio (TER) in Mutual Funds?

The Total Expense Ratio or TER in mutual funds is the fee that an Asset Management Company (AMC) imposes every year on investors to cover the cost incurred for running a mutual fund scheme. It is computed as a percentage of the overall Assets Under Management (AUM). Generally, the TER consists of a base TER, additional expenses as per Regulation 52(6A)(b) and 52(6A)(c), and Goods and Services Tax (GST).

How is the TER in Mutual Funds Decided and Charged?

Asset Management Companies (AMC) charge the expense ratio based on the rules and regulations of the Securities and Exchange Board of India. The guidelines concerning TER in mutual funds are different for non-equity oriented and equity-oriented mutual fund schemes. 

Here’s a tabular representation of the maximum TER that a fund house can charge for different types of mutual fund schemes:

Now let’s take a look at some charges that AMCs may levy over and above TER:

• Brokerage and transaction costs: Not exceeding 0.12% in case of cash market transactions and 0.05% in case of derivatives transactions
• Expenses not more than 0.30% of daily net assets contingent on specific minimum inflows from B30 (beyond the top 30 cities)

Besides these, note that a fund house can levy additional expenses of up to 0.20% of the daily net assets of a scheme. That said, such additional expenses are not applicable for close-ended schemes, ELSS funds or any scheme that does not have an exit load. 

Also Read: Top 10 Demat accounts in India in 2022

Components of TER in Mutual Funds

Fund management fees

This constitutes a key component of the total expense ratio. In order to meet the cost of running an office, recruiting staff and managing funds, AMCs deduct this fee from the fund corpus. This is a fixed cost that is higher for active funds than passive funds. 

GST

For the fund management services provided by AMCs, an investor needs to pay GST. The current GST rate stands at 18%, making it a crucial cost component of mutual funds. 

Transfer agent fee

The transfer agent in mutual funds plays a similar role as the registrar of equity investment. A registrar takes care of all the unit holder services such as fresh investments, redemptions, account management, and corporate actions, including dividend payouts. In India, CAMS and Karvy are the principal transfer agents that hold such activities. 

Commissions and brokerage

In mutual funds, there are two kinds of payable commissions – brokerage and statutory charges. These are payable due to the execution of transactions in debt and equity as part of routine portfolio management and commissions to the distributors who sell the products. 

Marketing and operating costs

The costs incurred on daily operations are the operating costs. It includes marketing expenses, such as the cost of advertising, branding, promotional activities and more. Note that if you invest in direct plans of mutual fund schemes, fund houses do not need to pay commission to the third-party agent (broker or distributor). 

Significance of TER in Mutual Funds

The importance of TER in the mutual funds is discussed below:

• It describes a mutual fund’s operating cost concerning its assets. 
• TER measures a fund’s operational efficiency. 
• It helps investors determine if the funds are an appropriate investment or not. Moreover, they can pay attention to the expense ratio and check if the fees being charged are suitable for the funds.

Moreover, while evaluating a fund, an investor is always advised to give preference to funds with decreasing TER. This is because the lower TER results in higher returns. Additionally, the TER is published in all factsheets from each fund, and it will be incurred devoid of the fact that the scheme has generated positive returns for the investor or not. 

Further, the TER is dependent on the fund management style, and one can quickly point out the difference between active and passive funds. This happens because passive funds do not require active management like the identified index. 

How to Calculate TER in Mutual Funds?

To understand TER calculation, you might want to consider the following illustration:

An equity mutual fund manages total assets worth Rs. 200 crores. The administrative fees associated with this fund is Rs. 80 lakh and management fees is Rs. 90 lakh. In addition, there are other expenses that amount to Rs. 50 lakh. 

Therefore, Total expenses = Administrative costs + management fees + additional expenses

                                            = Rs. (80,00,000 + 90,00,000 + 50,00,000)

                                            =Rs. 22,000,000

TER = Total expenses/Total assets

        = 22,000,000/2,00,00,00,000

        = 0.011 or 1.1% 

Now that you know the calculation of TER, you might want to compare various funds with respect to their expense ratios and choose the best suitable option. In this regard, you may consider investing in the Navi Nifty 50 Index Fund offered by Navi. This fund comes with the lowest expense ratio (0.06%). You can start investing in the Navi Nifty 50 and other Navi Mutual Funds through Zerodha, Paytm Money and Groww, to name a few.

*Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.

How Does TER Impact the Returns of a Fund?

Since TER in mutual funds is a percentage of the overall fund assets, it has a significant impact on investors’ returns. 

For example, let’s say that a mutual fund scheme has a TER of 2.25% and generates a profit of 18%. Thus, the total returns on the investment will stand at 15.75%. It is evident from this example that a lower TER will result in a higher profitability rate. 

Nevertheless, a higher TER does not necessarily mean lower returns as it also depends on the funds under management. You might still want to keep a lookout for this aspect as it directly affects the fund’s Net Asset Value (NAV). 

Additionally, investors might want to compare the TER of different funds and ensure the costs do not outweigh the benefits. 

Also Read: Key differences between SIP and mutual funds

Why Does TER in Mutual Funds Keep Changing?

TER of mutual funds changes over time. These changes happen on a monthly or quarterly basis. There are two main reasons why the TER keeps on changing – change in AUM and to remain competitive in the market. 

When the TER of funds increases, the mutual fund managers receive a low return, but the investors receive a higher return when it decreases.  

Limitations of TER in Mutual Fund

SEBI has imposed specific limitations on TER. Moreover, the TER is supposed to include all costs an investor is expected to incur. However, many costs are excluded like stockbroker fees, commission, annual adviser fees and the security transfer.

Final Word

When choosing a mutual fund scheme, it is imperative that you compare the expense ratio of different funds in the same category. That said, considering the TER in mutual funds is not enough. Make sure to take into account other vital aspects, such as your financial goals, the experience of fund managers, and past returns of the scheme before investing.

FAQs on TER in Mutual Funds

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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.

This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.