Whenever discussion happens on mutual fund, Net Asset Value (NAV) takes much of the focus. While choosing the mutual fund, one generally tracks the NAV performance over a period of say 1-5 years. But hardly anyone bothers to look how expense ratio has been during the period. If you are new to this asset class, then you must know expense ratio and its implications on the returns from your mutual fund investments.
What is expense ratio?
Like any financial instrument, mutual fund also incurs some charges in the form of agent commissions, distributor fee, management fee, registrar fee, as well as the expenses on selling and promoting. Expense ratio, which refers to the recurring cost per unit incurred for the running of the mutual fund scheme, is charged as a certain percentage of the average net assets of the fund on a weekly basis. The calculation of mutual fund expense ratio is made periodically and gets charged daily on the NAV. You will get the disclosure of expense ratio in March and September every year.
Expense ratio is maximum in India and China with more than 2% compared to 1%-1.70% in rest of the world. Adding service tax, some of India’s Asset Management Companies (AMCs) are charging expense ratio at well over 3%, thus eating out a huge chunk of the returns that an investor expects from mutual funds.
Impact of expense ratio
Suppose you have invested Rs 5 lacs in a mutual fund whose expense ratio is 2%, then it means you are paying Rs 10,000 each year to the AMCs. And if the annualised return is 18%, then the actual return after deducting expense ratio will thus reduce to 16%. NAVs are calculated after deducting expenses. So, a higher expense ratio will dry out the returns for you.
SEBI norms on mutual fund expense ratio
The Securities and Exchange Board of India (SEBI) has placed certain norms with regard to mutual fund expense ratio. These norms are stated in the table below.
|Net Assets||Equity Funds||Debt Funds|
|First Rs 100 cr||2.50%||2.25%|
|Next Rs 100 cr||2.25%||2%|
|Next Rs 300 cr||2%||1.75%|
The SEBI has also allowed retail investors to buy mutual fund directly from the AMCs and not through the distributor as the latter incurs additional charges. If you buy the scheme directly, then the NAV of your chosen fund will be free from the distribution fee and thus it will be reasonably higher. With this, you can enhance the returns on your investment.
How can one find expense ratio?
Whenever you subscribe to a mutual fund scheme via New Fund Offer (NFO), go to the Fees and Expenses of the Scheme section in the offer document to know the maximum expense ratio of the chosen fund. When it comes to the existing scheme, you can refer to the monthly fact sheet or the Key Information Memorandum to know the expense ratio.
When does expense ratio matter?
If you are investing in mutual funds for a shorter time frame of say 1-2 years, then expense ratio won’t impact your returns much. But the expense ratio can reduce your return significantly if the investment is held for say 5-20 years. So, if you want to be long-term mutual fund investor, you must check the past expense ratio as well as read the projections and performance of the fund that you are interested in buying. However, lower expense ratio does not necessarily lead to a professionally managed fund. A good fund though is defined by the higher returns at minimal expenses.