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Why is expense ratio of a mutual fund scheme important?


What is the expense ratio in a mutual fund scheme?

This is a ratio that measures per unit cost of managing a fund. It is calculated by dividing the fund’s total expenses by its assets under management. There are various costs an AMC incurs that form part of the expense ratio. For example, the AMC has a fund management team that tracks companies in the portfolio. They make decisions to buy and sell securities to meet the objectives of the scheme. The fund house also incurs expenses, such as for transfer and registrar, custodian, legal, audit fees, and fees to be paid for marketing and distribution of its products. All such costs are recovered from its unit holders on a daily basis. The daily net asset values (NAVs) of a fund scheme are reported after deducting such expenses.

Why is expense ratio higher for regular plans as compared with a direct plan?

In a direct plan of a mutual fund scheme, you buy directly from the mutual fund company, whereas in a regular plan, you buy through a distributor (intermediary). In this regular plan, the mutual fund company pays commission to the intermediary, which is then recovered as an expense ratio from the plan. Hence, the expense ratio is higher in a regular plan.

What are the regulatory ceilings for expense ratio?

Market regulator the Securities and Exchange Board of India has set a ceiling for the expense ratio. It has created various slabs based on assets under management for open-ended equity-oriented mutual fund schemes. For the first 500 crore, they can charge 2.25%, for 500-750 crore, 2%, for 750-2,000 crore, 1.75%, 2,000 to 5,000 crore, 1.6%, 5,000 to 10,000 crore 1.5%, for 10,000 to 50,000 crore reduction of 0.05% for every increase of 5,000 crore and for AUM greater than 50,000 crore, 1.05%.

Does the expense ratio impact fund returns?

Expense ratio indicates how much the fund charges in terms of percentage annually to manage your investment portfolio. If you invest`10,000 in a fund which has an expense ratio of 2%, then it means that you need to pay `200 to the fund in order to manage your money. So if a fund earns 12% return and has an expense ratio of 2%, then you would earn a return equal to 10%. A lower ratio can increase your profitability and a higher ratio means less profitability. Although a high expense ratio impacts the fund returns, it is not necessary that a high expense ratio will always give low returns. Investors need to keep track of a host of other factors while choosing their scheme.

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