Understanding Total Expense Ratio (TER) in Mutual Funds
What is Total Expense Ratio (TER) in Mutual Funds
Total Expense Ratio in Mutual Funds is the measure of the total cost of investing in a mutual fund to the investor. It can also be defined as the total fees charged by the asset management company (AMC) for operating and managing a mutual fund scheme.
Few factors contributing to the Total Expense Ratio (TER)
- Management Fee: Asset Management Companies (AMCs) charge this fee to cover the costs of running the Company.
- Distribution Fee: To increase the penetration of mutual funds and increase its reach, asset management companies (AMCs) engage with mutual fund distributors who help in selling these MFs to the customers. These distributors charge a certain commission to the asset management companies (AMCs) and these costs are in-turn passed on to the investors by AMCs. This is known as distributor fees. This fee is charged only for regular mutual funds and not for direct mutual funds. Base TER of direct plan shall have a lower expense ratio excluding distribution expenses, commission, etc., and no commission shall be paid from such plans. This fee charged to the customer may include any marketing expenses incurred by the AMC.
- All Other Scheme Operating Charges: These charges include administration fees, maintenance charges etc. Some of the other expenses contributing to the TER of the scheme are mentioned here.
Other charges to take care of when investing in MF
- Entry Load: AMCs collect money from the investor at the beginning of their investment in a mutual fund. The fee charged is called Entry Load. It is usually deducted from the investment amount reducing the total amount of upfront investment. In 2009, SEBI decided that there shall be no entry load for all Mutual Fund Schemes.
- Exit Load: AMCs collect money from the investor when the investor redeems their investments either partially or fully within a certain period of time. This fee is charged to discourage investors from exiting the scheme before a certain period of time. [1] Zerodha Fund House does not charge exit load in its schemes.
Total Expense Ratio (TER) limit in Index Funds and Fund of Funds
TER has a direct bearing on a scheme’s NAV – the lower the expense ratio of a scheme, the higher the NAV. Thus, TER is an important parameter while selecting a mutual fund scheme.
As per the existing SEBI Regulations, mutual funds are required to disclose the TER of all schemes on a daily basis on their websites as well as AMFI’s website.
SEBI (Mutual Funds) Regulations, 1996 has defined maximum permissible TER limits for mutual fund schemes.
The TER of funds that fall in the category of “other schemes” are as follows:
In case of Fund of Funds:
(i) investing in liquid schemes, index fund schemes and exchange-traded funds, the total expense ratio of the scheme including a weighted average of the total expense ratio levied by the underlying scheme(s) shall not exceed 1.00 percent of the daily net assets of the scheme.
(ii) investing a minimum of 65% of assets under management in equity-oriented schemes as per scheme information document, the total expense ratio of the scheme including a weighted average of the total expense ratio levied by the underlying scheme(s) shall not exceed 2.25 percent of the daily net assets of the scheme.
(iii) investing in schemes other than as specified in (i) and (ii) above, the total expense ratio of the scheme including a weighted average of the total expense ratio levied by the underlying scheme(s) shall not exceed 2.00 percent of the daily net assets of the scheme
[2] All the schemes of Zerodha Fund House are direct plans.
Calculation of Total Expense Ratio (TER)
Let’s break down the calculation of TER with an example. Let’s say we have invested Rs. 1000 in a fund for 5 days. The expense ratio charged is equal to 0.5%. This means that 0.5% is charged for a period of 1 year. Hence, the TER is charged on a daily basis over a period of one year.
Let’s say the returns earned on a daily basis by the fund is equal to 1%. Then the calculation breakdown looks like this:
Total Expenses = Sum of all daily expenses = 0.0689/-
Formula of TER
TER is calculated based on the formula (Total Expenses of the fund/Total Assets Under Management (AUM) of the fund)
Let’s say a mutual fund scheme manages a total assets of 300 Cr and the total expenses involved in managing the fund is 75 Lakhs, then the TER = (75 Lakhs/300 crores) *100 = 0.25%.
Impact of TER on Mutual Fund Returns
TER is an extremely important factor in choosing the right mutual fund. If you have a choice between two mutual funds and if the return potential with both the funds are the same, even a small difference in the expense ratios can cause a big difference in net returns over a period of time.
For example, say you have two mutual funds - Mutual Fund A and Mutual Fund B. If you have invested 1000 is both the funds and both funds give the same return of 10% over a period of 5 years. But the expense ratio of one fund is 0.28% and the other is 0.5%.
Then the Net Return would be 9.72% for Mutual Fund A and 9.5% for Mutual Fund B. The Investment Return for Mutual Fund A would be 1590/- and for Mutual Fund B would be 1574/-. The difference in the returns would seem to be very small, but imagine the difference over a period of 15-20 years with an investment corpus much larger than 1000/-.
Hence, it is very important to understand the impact of TER before making investments in mutual funds.
Where can we find the TER for different Mutual Fund schemes
- Asset management Company Website: The TER is updated every day on the AMC’s website. It is also available on the fund factsheet also.
- Financial Information Websites and Distribution Platforms: The TER for both direct and regular plans of the scheme is disclosed on various online distributor platforms and other financial websites.
- Association of Mutual Funds in India (AMFI): This is another platform that discloses the Expense Ratio of all mutual funds. It is mandated by SEBI for all AMCs to disclose the TERs of all their funds on the platform.
Conclusion
The total expense ratio is a very important factor to consider when selecting/investing in mutual funds, as lower TER may potentially result in higher returns.
However, TER should not be the only factor when investing in mutual funds. There are a bunch of other factors that are very important in conjunction with the Total Expense Ratio (TER) to make an informed investment decision.
[1]: This statement regarding Zerodha Fund House schemes not charging exit loads is in accordance with the applicable SEBI (Mutual Funds) Regulations, 1996 and directives issued by SEBI in this regard and reflects the status as of date of issuance of this blog. Please note that regulations and fund policies are subject to change, and it's advisable to verify the current terms and conditions before making any investment decisions. The information provided does not constitute financial advice in any manner whatsoever.
[2]: This statement regarding Zerodha Fund House schemes offering only direct schemes is in accordance with the SEBI Mutual Fund Regulations and reflects the status as of date of issuance of this blog. Please note that regulations and fund policies are subject to change, and it's advisable to verify the current terms and conditions before making any investment decisions. The information provided does not constitute financial advice.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully
Please note that this article or document has been prepared on the basis of internal data/ publicly available information and other sources believed to be reliable. The information contained in this article or document is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party in any manner. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article or document.
Published on May 2, 2024
