Saving is Earning is what old wisdom says. Today its true more than ever as the difference between actively managed funds and benchmarks keep coming down. In this article, we understand the various charges deducted by mutual funds on your invested money via expense ratio and exit load.
What is the Meaning of Expense Ratio?
Mutual funds are permitted to charge operating expenses for managing a mutual fund scheme. These expenses are charged as a percentage of the fund’s daily net assets and are referred to as expense ratio.
Simply put, the expense ratio is a ratio that measures the per unit cost of managing a fund and is expressed as a percentage.
What is the Formula for Expense Ratio?
To arrive at the expense ratio, one has to divide the total fund costs with the total fund assets. The result is the expense ratio that is expressed in a percentage format
Why is Expense Ratio Important?
The expense ratio represents the cost of managing 1 unit of the mutual fund to whom you have entrusted your funds.
Like all things, if you can get something at a lower price point then you would have saved some money which means more money in your pocket. The same holds true for investments i.e. lower the expense ratio, possibly higher is your return.
The SEBI Mutual Fund Regulations have prescribed clear limits that mutual funds need to follow with regards to it’s expense ratio. This is done to protect the investor’s interest as more people have been appreciating the benefits of mutual fund investing.
Afterall, there is an incentive for the mutual fund company to charge more expenses from the investor. They have done so many times in the past to offer higher fees & incentives to distributors who then bring in more money into the funds. While this is good for the mutual fund companies, it comes at the cost of the investor’s returns.
And hence to ensure good prudent practices, SEBI came hard on mutual funds to reduce their TER in September 2018.
SEBI is following the global trend where expenses in mutual funds and other financial products related to investments are coming down. The below chart shows a 30 bps reduction in actively managed mutual funds over the last two decades. But the index funds has been the hero of this story as it now averages just 8 bps of expenses
However, remember one thing.
Although high expense ratio impacts fund returns, it is not necessary that high expense ratio will always give low returns.
We shall learn more about the importance of lowering expenses ratios in a later example in this post.
Where can you find the Expense Ratio of a Mutual Fund scheme?
The expense ratio of a mutual fund scheme can be accessed on the mutual fund company website.
For example – if I want to know the expense ratio of ICICI Prudential Bluechip Fund, there are the steps I took:
- Search for ICICI Prudential Mutual Fund on google.com
- Enter mutual fund company website and search for bluechip funds in plans
- Search for the section where it says “Expense Ratio”
The website clearly shows that the current expense ratio of the ICICI Prudential Bluechip Fund is 1.15% for the direct plans and 1.77% for the regular plans
I have a well-research article that illustrates the difference between direct and regular mutual funds with many examples and gets into some detailed provisions. Do have a read.
For more convenience you can also visit mutual fund aggregation websites like ETMONEY, ValueResearchOnline or MoneyControl to retrieve the same information.
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What types of expenses constitute a mutual fund expense ratio?
A mutual fund company incurs a number of expenses on a daily basis. These expenses get accumulated and charged to the mutual fund investor as an expense ratio. The expenses incurred by a mutual fund include –
- Transaction costs*
- Investment management fees**
- Administrative expenses***
- Sales & Marketing expenses
- Distribution fees
- Audit fees
- Registrar fees
- Custodian fees
- Other operating expenses.
A total of all these constitute a mutual fund scheme’s expense ratio.
I’d like to talk about three expenses in particular
* Transaction costs – This is the cost of buying and selling securities like stocks, ETFs, funds, derivatives etc. which is a primary or core part of the mutual fund’s business. The more the number of transactions, more are the transaction costs. It is interesting to know that some funds spend way lower than other funds because their investment mandate does not require them to actively buy and sell.
** Investment fees (also called fund management charges) – This is the expenditure incurred in researching through numerous securities by fund managers, fundamental analysts, technical analysts, pouring over data reports, attending earnings calls, meeting management teams etc. The idea of this activity is to take the most apt decision on behalf of the investor so that the fund’s objectives can be met. This investment advisory fee is a compensation for expertise of these professionals and on an average, are about 0.50% to 1.00% of the fund’s assets.
*** Administrative expenses – A large portion of a mutual fund’s investors are offline i.e. requests reach the AMC (asset management company) via their branches which are accessed by agents and customers alike. Additionally there are customer support layers that need to be maintained to ensure a smooth functioning of operations & help to investors. As more investors & distributors embrace technology, we might see dips in these expenses.
What is the maximum expense ratio set by the market regulator (SEBI)?
The Securities and Exchange Board of India (SEBI) brought about important changes in rules of which one was aimed at reducing the total expense ratio (TER) charged by mutual funds to investors. Per these new regulations, all expenses of an AMC must be managed within the limits specified under Regulation 52 of SEBI’s Mutual Fund Regulations.
New Total Expense Ratio structure (or TER structure) is available in the below table
|AUM Slab (in ₹ crores)||TER for Equity Oriented Schemes||TER for Other Schemes (excl. Index, ETFs and Fund of Funds)|
|0 – 500||2.25%||2.00%|
|500 – 750||2.00%||1.75%|
|750 – 2,000||1.75%||1.50%|
|2,000 – 5,000||1.60%||1.35%|
|5,000 – 10,000||1.50%||1.25%|
|10,000 – 50,000||TER reduction of 0.05% for every increase of ₹5,000 crores AUM or part thereof||TER reduction of 0.05% for every increase of ₹5,000 crores AUM or part thereof|
Now, the whole of last year and a large part of 2018, you might have received many emails from mutual fund companies regarding the change in their total expense ratios.
You may continue to receive it as mutual fund companies keep on changing their TER at regular intervals. For example, this is the email I received from HDFC Mutual Fund with regards to their Small Cap Fund TER changes.
How does expense ratio impact fund returns?
The Expense Ratio indicates the charges incurred by the fund to manage your investment portfolio. This means, if you are investing in a fund which has a 2% expense ratio, then 2% shall be deducted from your AUM.
Let’s understand this with an example where we feature two funds – Fund A and Fund B
|Fund A||Fund B|
|Amount Invested on 1-Jan-2019||₹1,00,000||₹1,00,000|
|Net Annual Returns||13%||14%|
|Corpus on 31-Dec-2019||₹1,13,000||₹1,14,000|
We see that a lower expense ratio gives a proportional lift to your fund’s returns.
You might also be too casual about this number knowing that it’s just an improvement of ₹1,000 over a ₹1,00,000 investment.
Let’s measure the impact of this over a longer period and let’s make it more practical with a monthly SIP investment strategy of ₹5,000.
We assume you are investing ₹5,000 every month over the next 20 years.
|Fund A||Fund B|
|Amount Invested over 20 years||₹12,00,000||₹12,00,000|
|Net Annual Returns||13%||14%|
|Corpus after 20 years||₹57,27,596||₹65,81,731|
As shown in the table above, that small 1% change in return (on account of savings in expense ratio) actually gives you a 15% improvement in the returns.
Why is the expense ratio higher for a regular plan as compared to a direct plan?
Direct plans have a lower expense ratio than regular plans.
This is the case because the mutual fund company does not pay any commission on direct plans and the entire savings is passed onto the investor.
Expense ratios in regular plans are higher as the distributor’s commission is baked in the expense ratio itself.
Let’s examine this with a small example.
We see above that the difference in expense ratio of the direct plan and regular plan of Aditya Birla Sun Life Frontline Equity Fund is 0.80%. This means the distribution fees paid by this mutual fund is 0.80%.
Let’s see L&T India Value Fund direct and regular plans aswell.
Here the difference is even higher with over 1% differential in the expense ratio of direct and regular plans of this mutual fund scheme
Continuing to opting for regular plans is one of the many mutual fund mistakes that new-to-investing users make. As a general rule, try to invest in direct plans as compared to regular plans as it will enhance your wealth over the short and long run.
What are the expense ratios for non-equity (debt mutual funds), index funds and ETFs?
|Type of scheme||Maximum permissible TER|
|Equity-oriented close-ended or interval schemes||1.25%|
|Other than equity-oriented close-ended or interval schemes||1.00%|
|Index Funds/Exchange Traded Funds (ETFs)||1.00%|
|Fund of Funds investing in actively managed equity-oriented schemes||2.25%|
|Fund of Funds investing in actively managed other than equity-oriented schemes||2.00%|
|Fund of Funds investing in liquid, index and ETFs||1.00%|
Which funds have the lowest expense ratios?
The lowest expense ratio mutual funds are generally the liquid and overnight funds under the direct plan.
Liquid and Overnight funds with the lowest expense ratio
The below table shows that liquid funds and overnight funds have expenses as low as 0.04%
Debt mutual funds with the lowest expense ratio
Excluding liquid and overnight funds, I see that short duration funds have a low expense ratio that ranges from 0.08% to 0.20%
- Best Ultra Short Duration Funds for 2020
- Best Low Duration Funds for 2020
- Best Money Market Funds for 2020
What is Exit Load in a Mutual Fund?
An exit load is a cost (expense) borne by the investor who redeems or switches one’s mutual fund units before a predefined time window. Exit loads are charged as a mechanism to deter investors from premature withdrawals.
For equity funds, an exit load is usually charged if the investor exits before a one year period. This time window can be more than one year also (as seen in some Quantum Mutual Fund schemes) and can be zero also (as seen in some Motilal Oswal schemes).
Do remember, an exit load is entirely different from the incidence of tax on mutual funds. Some investors tend to get confused and incorrectly state that by avoiding exit load, they can avoid taxes. That is certainly not the case. Exit loads and taxation of mutual funds are two independent topics.
Do all schemes levy exit load?
No. All schemes do not levy exit loads. For example, there are no exit loads in most short duration debt funds. Similarly, the period or window for applicability of exit load can be as low as a day, a week, a month, a quarter or an year in case of debt funds.
In equity funds, while most fund houses have exit loads, Motilal Oswal AMC is one exception which does not have exit loads in a few equity schemes of theirs.
Why is exit load levied?
Exit loads are a way to discourage investors from early redemption. Investors who redeem too often as well, more like speculators and the money they represent is referred to a “hot money”.
From a fund management point of view, an assurance of the money not flowing out on whims gives the fund manager room to better plan investments. Or else, the fund manager would be forced to keep a portion of his corpus as cash for any ad-hoc redemption pressures that might come in if the exit load was nil.
Can exit load be avoided by investors?
Yes. Be smart about tracking when you bought the mutual fund units and when you plan to sell them. If you sell them outside of the window period, then you can easily avoid exit load.
For example – I keep a track of when investments are made. I used to do this on an excel sheet but now I upload my portfolio in a few online investment portals. Some of these portals have a smart redemption feature which prompts me of the estimated exit loan amount I might have to pay upon redemption of units.
What are the Exit Loads in Liquid Funds?
In October 2019, SEBI introduced a new structure of exit loads for liquid funds.
Until then, liquid funds did not attract any exit loads and was a very popular way for individual investors and especially corporates & institutions to keep their idle money in. This directive by SEBI was aimed at minimising the impact of frequent inflows and outflows by institutional investors which was leaving smaller investors vulnerable.
The graded exit load structure for liquid fund is as follows:
|Redemption on||% of AUM|
|Day 7 & onwards||No exit load|
In the notice, SEBI also informed that the exit load structure for liquid funds will be changed every year on the basis of the interest rates in the system.
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What is Entry Load in a Mutual Fund?
An entry load is the fee charged from an investor while entering a scheme.
This amount was charged from the investor to cover the costs of distribution by the mutual fund company. There was no uniform rate and different mutual funds houses charged different fees as entry load. This charge was usually about 2.25% of the value of investment.
From August 2009, SEBI completely moved away from this practice of charging entry load on mutual funds.
Are there any MyCAMS Charges that are levied?
I picked up this question as many investors were asking this question.
MyCAMS is a web based application (and now mobile application) developed by CAMS. This online tool was designed to help investors access their investments in all CAMS operated AMCs in one place.
Using the website or mobile app, investors can purchase, redeem, switch, create SIPs, create SWPs and view their dashboard with a one view of all AMCs managed by CAMS RT&A. This includes the biggies like ICICI Prudential, HDFC, Aditya Birla and others.
MyCAMS offers this service free of cost and does not charge any costs to investors for using this service
I myself use MyCAMS to have a view of a number of schemes in which I have invested and find it quite useful as I don’t have to log onto different websites of AMCs to access my portfolio.
In addition to MyCAMS, you can explore many other alternatives which give you access to mutual fund companies services by CAMS, Karvy and Franklin Templeton RT&As. These include –
- PayTM Money