Expense ratio is the annual maintenance charge levied by mutual funds to finance its expenses. It includes various costs of the fund.
Expense ratios have an inverse relationship with size of the respective mutual fund. Expense ratio formula depicts-total expenses divided by total assets of the funds.
A fund operating with a small amount of financial resources has to allocate a certain proportion towards optimal management, increasing the relative value of the expenses. In case of large-cap mutual funds, the amount of expenses is smaller subject to the total asset value.
Components Of Expense Ratio:
Mutual fund costs and its breakups are released to the investors. A statement is released every 6 months, depicting the amount deducted from the account of the investors to meet these costs.
1.Management fees is allocated to pay the Portfolio and fund managers devote who considerable time and energy to determine profitable investment opportunities through rigorous market research and calculated predictions.0.5-1% of the total asset base is deducted as management fees usually.
2.Total cost incurred to maintain proper records of the investors, entry and exit fees of the portfolio assets, customer support, etc. can be categorized as Maintenance cost.
3.12B-1 fee is the amount spent on the promotion and information to be spread among the masses regarding adequate asset base. New individual investment cost is calculated under the 12-b FEE.
4.Entry Load is the amount that has to be paid by an investor while joining a mutual fund and is part of total expense ratio. Different mutual funds charge different percentages on entry, at discretion of AMC. As per SEBI regulations, the entry load is abolished from the calculations of the total expense ratio.
5.Exit load is the amount payable usually at 2-3% when a person chooses to withdraw from a mutual fund. This discourages people from withdrawing funds from a mutual fund.
6.In case of regular plans, (AMC) hires a broker for all purchase and sale of the shares of the portfolio asset and pays Brokerage cost. Direct mutual funds process these transactions by themselves.
This is an add on expense for a regular fund, while direct funds do not have this burden. Mutual fund expense ratio list of every such fund is readily available on the official website, to give complete knowledge about the product blocking a substantial amount of their finances. Expense ratios also depend upon the duration and maturity of a mutual fund.
Impact of the Expense Ratio:
Higher expense ratios imply a higher proportion of the returns being removed, providing lower returns on investments. An investor should carefully analyse the same while choosing a mutual fund scheme to invest.
Expense Ratio Implications
A higher expense ratio indicates better management of a mutual fund, with a higher probability of generating profits. Mutual funds which have a low expense ratio, managed by trained managers with proper market predictions can yield high returns. Mutual funds having a high expense ratio, can be aggressively managed for higher yields, or invest in companies having higher profits.
Expense Ratio Limit by SEBI
Expense ratios charged by an AMC on their mutual funds are subject to restrictions imposed by the SEBI. They are different for Exchange Traded Funds and Index Funds. For an initial asset base of Rs. 500 Crore of a fund, a maximum total expense ratio is of 2%, for next Rs. 250 Crore, a ratio of 1.75%, and any asset base higher than that is processed at 1.5% respectively.
An AMC can charge a maximum of 2.5% as the total expense ratio for the first Rs. 100 Crore of the portfolio. For subsequent asset value of Rs. 300 Crore, a rate of maximum 2.25% is deductible, 2% can be charged on subsequent slabs concerned with the rest.
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Bhoi Smrutirekha Dharanidhar