When you buy mutual fund units from a fund house or through a broker, you would notice that the total cost of the fund includes a fee in the form of total expense ratio or TER. This fee includes commission and operational charges that goes towards managing a fund. This adds up to the total fund cost. But does the TER of a mutual fund have any impact on your investments?
In this blog, we have explained TER meaning in mutual funds and why every investor should consider a fund’s TER before investing their money. Let’s dive in.
The Total Expense Ratio or TER in mutual funds is the fee that an Asset Management Company (AMC) imposes 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).
The formula for calculating expense ratio is as follows:
Expense Ratio= (Total costs that are borne by the mutual fund)/(Average assets under management)
Total costs borne by mutual fund = Costs incurred by the fund house such as expenses of distribution, marketing, legal/audit and fund manager’s fee
Average Assets under Management = Total value of the money of the investors kept in the fund
Let us understand the calculation with the help of an example. Suppose an equity fund has AUM of Rs.600 crore. and the expenses sum up to Rs.12 crore.
Therefore, the expense ratio formula would be Rs.12 crore/ Rs.600 crore = 2%
So, 2% will be charged as expense ratio.
Here are some of the of the major components of total expense ratio that you should know of:
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:
|Assets Under Management||TER for equity-oriented funds||TER for non-equity oriented funds|
|On the first Rs. 500 crore||2.25%||2.00%|
|Next Rs. 250 crore||2.00%||1.75%|
|Next Rs. 1,250 crore||1.75%||1.50%|
|Next Rs. 3,000 crore||1.60%||1.35%|
|Next Rs. 5,000 crore||1.50%||1.25%|
|Next Rs. 40,000 crore||TER reduction of 0.05% for every increase of Rs. 5000 crore of daily net assets or part thereon||TER reduction of 0.05% for every increase of Rs. 5000 crore of daily net assets or part thereon|
|Above Rs. 50,000 crores||1.05%||0.80%|
Now let’s take a look at some charges that AMCs may levy over and above TER:
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.
The total expense ratio (TER) can have a significant impact on the returns of a mutual fund or exchange-traded fund (ETF) over time. In general, funds with higher TERs will have lower returns than similar funds with lower TERs, all else being equal. This is because the higher costs associated with the fund eat into the fund’s returns.
It is important to consider the TER when choosing a mutual fund or ETF. By selecting a fund with a lower TER, you may be able to maximize your returns over the long term. However, it is important to note that the TER is just one factor to consider when evaluating a fund, and it should not be the only criteria used to make investment decisions.
Market regulator SEBI (Securities Exchange Board of India) has put in place various guidelines with regard to the maximum expense ratio that a fund house can charge. Primarily, there are two reasons why fund houses keep changing their TER. Let us take a look at them:
The AUM of a mutual fund undergoes daily changes. But, it is not possible for a fund house to keep changing TER every day which is why TER changes, most commonly take place either quarterly or monthly.
Fund houses alter their TER strategies to remain competitive and attract more investors. Often, an AMC deliberately keeps its expense ratio lower than its peers and once it has attracted a large number of investors, it increases its TER.
The following chart illustrates the SEBI guideline for TERs in mutual funds:
|Asset Under Management Slabs||TER Limits for Equity Oriented Funds||TER Limits for Other Mutual Fund Schemes (excluding Index Funds, ETFs and Fund of Funds)|
|0 – Rs. 500 crore||2.25%||2.00%|
|Rs. 500 crore – Rs. 750 crore||2.00%||1.75%|
|Rs. 750 crore – Rs. 2,000 crore||1.75%||1.50%|
|Rs. 2,000 crore – Rs. 5000 crore||1.60%||1.35%|
|Rs. 5,000 crore – Rs. 10,000 crore||1.50%||1.25%|
|Rs. 10,000 crore – Rs. 50,000 crore||TER decreases by 0.05% for each AUM increase of Rs. 5,000 crore or part thereof||TER decreases by 0.05% for each AUM increase of Rs. 5,000 crore or part thereof|
|Over Rs. 50,000 crore||1.05%||0.80%|
Apart from the expenses mentioned in the chart, the following expenses can be charged to the schemes:
When choosing a mutual fund scheme, it is advised that you compare the expense ratio of different funds in the same category. That being 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.
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Ans: An index fund has a lower total expense ratio than equity funds or any other active funds as its management costs are low. Index funds are passively managed funds where fund managers simply track the underlying benchmark index. This is why they charge a lower management fee.
Ans: In the case of regular plans, fund houses pay out commissions to brokers and distributors who sell several products to their customers. To procure clients, one might need to pay upfront brokerage, and for retaining clients in the fund, there is a trail commission. However, in the case of direct plans, AMCs need not pay any distribution fees as no financial intermediary is involved. Due to this, the TER in mutual funds is lower for direct plans than regular plans.
Ans: Here’s the formula for net asset value (NAV):
NAV = [Overall Assets – (Total Liabilities + Total Expenses)] / Number of outstanding units
As you can see, the expenses of the fund are taken into account when computing NAV. Accordingly, the higher the expenses, the lower will be the fund’s NAV.
Ans: Debt funds generally yield lower returns than equity funds. For instance, let’s say you choose a debt fund with an expense ratio of 2%. Considering the average returns of a debt mutual fund scheme is between 6%-9%, you might consider choosing a fund with a minimum expense ratio for maximum returns.
Ans: AUM is the total value of assets held in a mutual fund scheme’s portfolio. As per SEBI regulations, AMCs can charge the maximum expense ratio based on the AUM. Therefore, if there is a change in a fund’s AUM, its expense ratio also changes.
Ans: As per SEBI regulations, mutual funds are required to disclose the TER for all schemes regularly on their website and the AMFI’s website. Moreover, the TER for equity funds should be 2.25%, and for debt funds, it should be 2% on the first 500 crore. Then one can consider the TER a good TER in mutual funds.
Ans: Mutual funds charge 2.5% for the first 100 crore of average weekly net assets. Further, for the next 300 crore the TER will be 2.25%, 2% for the next 300 crore and 1.75% for the balance AUM. This is considered the base total ratio 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.
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