Why should you consider Fund Costs?

It costs money to run a mutual fund smoothly.

The management and advisory fees make up the largest component of the expense

Do you buy items from a store without checking its price? Similarly, while selecting a fund, you need to know what the fund costs. Fees or fund costs are one of the principal considerations for choosing any mutual fund, especially fixed-income funds, and it does affect your return.

What are Fund costs?

It costs money to run a mutual fund smoothly. While some funds cost more than others to operate, some are associated with your account and transactions, which are charged directly from you at the time of transaction like buying or selling funds. These are loads, Redemption Fee, Exchange Fee, Account Fee, and Purchase Fee.

At the same time, funds pay their regular and recurring fund-wide operating expenses out of fund assets. As these expenses are paid out of fund assets, you are paying them indirectly. The expenses like Management and Investment Advisory Fees, Marketing and Distribution Fees and other expenses make up operating expenses known as Annual Fund Operating Expenses.

What is the expense ratio?

It is the Annual Fund Operating Expenses of a scheme, usually expressed as a percentage of the daily net assets of the fund. Operating expenses of a scheme include administration, management, advertising related fees, etc. For example, a 1% expense ratio per annum means that each year 1% of the fund’s total assets will be used to meet expenses.

The management and advisory fees make up the largest component of the expense ratio. An AMC generates profits from the management fee as well as marketing and distribution expenses. People who are involved in the fund operations like a custodian and auditors also get a share. Brokerage that fund pays on the purchase and sale of securities does not reflect in the expense ratio. Mutual funds state their buying and selling price after considering the transaction cost.

When is the expense ratio high and when is it low?

Small-cap and international funds carry a higher expense ratio than large-cap funds and domestic funds. Funds managed passively, or index fund is almost always less expensive than actively managed funds. Similarly, quantitative funds or quant funds usually carry lower expense ratios than funds managed fundamentally. Overall, fixed-income fund expenses are less than those of equity funds.

What is the impact of expense ratio on fund returns?

Expense ratio is charged regularly; therefore, a high expense ratio over the long term may significantly affect your returns as a result of the power of compounding.

For instance, Rs 1 lakh over 10 years at a rate of 15 percent will grow to Rs 4.05 lakh. But if an expense ratio is charged @1.5 percent, your actual total returns would be Rs 3.55 lakh, which is nearly 14 percent less.

A lower ratio means that profitability is more compared to a higher ratio. A high expense ratio impacts the fund returns. However, the high expense ratio does not always need to give low returns.Asset Allocation

What is the ceiling set by the SEBI for the Total Expense Ratio (TER) of Mutual Fund Schemes?

Several factors contribute to the total expense ratio of a fund, and expense ratios vary from fund to fund. However, the Securities & Exchange Board of India (SEBI) has set the upper limit that a fund can charge. The total expense ratio (TER) allowed for equity-oriented schemes is 2.5% for the first Rs.100 crore of average weekly total net assets, 2.25% for the next Rs.300 crore, 2% for the next Rs.300 crore and 1.75% for the rest of the AUM.

How do you get to know about the Expense Ratio?

An expense ratio that may apply to a scheme is mentioned in the offer document. At present, in India, the expense ratio is fungible. There is no limit on any particular type of allowed expense as long as the total expense ratio is within the prescribed limit as per limits on expense ratio, prescribed in regulation 52 of the SEBI (Mutual Funds) Regulations, 1996.

Do you need to pay anything to the distributor who sells you mutual fund schemes?

No entry load is chargeable on any mutual fund scheme. An investor can opt to pay a distributor after the assessment of various factors, including the service rendered by the distributor. However, when investments made through a distributor, the commission is paid to the distributor directly by AMC such that the total expense ratio for an investor is within expense ratio limits specified by the SEBI. Hence, the cost borne by the investor remains within the limit prescribed under SEBI Regulations.

What is a direct plan? Why it has a lower expense ratio than the regular plan?

Mutual funds have to compulsorily launch a direct plan for direct investments as per the SEBI mandate from 01 January 2013. Unlike the regular plan, investments through any direct plan are not routed through a distributor (intermediary). As no commission is to be paid from such plans, it has a lower expense ratio. The plan also has a separate NAV.

What should be your lookout as an investor?

The fees and expenses may be entirely appropriate based on the fund’s operations and may seem negligible. However, fees and expenses can substantially reduce an investor’s earnings when the investment is held for an extended period. These costs may be higher than what you can afford to pay. Decide whether a similar fund having lower expenses would make better sense for you. Remember, the more you pay in fees and costs, the less money you will have in your investment portfolio.

Therefore fees are a critical consideration while selecting any mutual fund, particularly fixed-income funds. It is essential to understand why a fee is high or low relative to other funds. Sometimes higher fees are justified as a fund having high costs that perform better than a low-cost fund to generate the same returns while other times they are not. Compare the total expense ratio and the fees of the various funds under consideration against industry benchmarks and averages. Take the help of your financial advisor to get the best returns on your investment.

That’s why Comparte Investment team asks do you have “Nivesh Ki Aadat”.

With this one can say “Mutual Fund Sahi hai”,  so let me do Nivesh