SEBI has recently asked the mutual funds to lower down their expense ratio to leverage the market width. As per SEBI, it will benefit the investor to get the better deal. Lower cost means higher returns to the investors. Before we go ahead on the benefits of lower expense ratio, let’s understand what is expense ratio.
What is Expense Ratio?
Mutual funds are the pool of money from the retail investors which help them to grow their money. Mutual fund company known as fund house runs different mutual funds scheme based on the different themes. AMCs (Asset Management Company) charges a fee to their investors for managing their funds and earning returns on them. This includes advertising and marketing expense, the salary of the fund managers, distributor’s commission, registrar’s fee. This cost is called Total Expense Ratio (TER). TER is expressed as a percentage of the total managed assets.
There is a capping by SEBI on the maximum TER that a fund can charge to its investors.
- Equity-oriented funds – 2.50%
- Debt-oriented funds – 2.25%
- Index funds – 1.50%
There is a sub-limit on equity oriented funds based on the size of the assets managed.
- First Rs.100 crore – 2.50%
- Rs. 100 crore to Rs. 400 crore – 2.25%
- Rs. 400 crore to Rs. 700 crore – 2.00%
- Above Rs. 700 crore – 1.75%
The only cost outside of this is exit load.
Fund manager’s fee and distributor’s commission are the two main components in the expense ratio. Mutual fund companies are charging this cost as indirect from the returns on the investments.
SEBI has taken various measures time to time to lower down the expense ratio of mutual funds. In 2012, it made mandatory for the AMC’s to launch “Direct” option in all the fund scheme. Direct plans saving a commission paid to the distributors. No commission means lower cost and higher returns. Since there is no commission to be paid under direct plans, the expense ratio is lower than the regular plans.
Based on the recommendation from Mutual Fund Advisory Committee, SEBI has decided to reduce the additional expenses charged by mutual funds by 15 basis points which will increase penetration among investors.
Why should I care?
Your returns from a mutual fund depend on the growth in its Net Asset Value (NAV). This NAV is calculated after reducing the TER from the latest value of the scheme’s portfolio. Hence higher the TER, the lower the return on your investment. the small increase in the expense ratio can have a disproportionate impact on the returns on the investments. Cost is not only the factor you should look into while selecting the fund, but when you have to make a choice from the two funds which are giving similar performance, that is the case where the expense ratio plays a crucial role. It is although the more important when the returns are fixed like in debt funds.