What Is Total Expense Ratio In A Mutual Fund And How It Is Calculated

These costs for running and managing a mutual fund scheme are collectively referred to as TER. Mutual fund schemes are currently permitted to charge the following four additional expenses, which are over and above the expense limits specified above.

First is the brokerage and transaction cost. This is incurred for the purpose of executing a trade and can be up to 0.12 percent of the trade value in the case of cash market transactions, and 0.05 percent of the trade value in the case of derivatives transactions.

Second additional expense is a Goods and Services Tax (GST) on investments, which is a maximum of 0.05 percent of the daily net assets of the schemes, with provisions for an exit load.

Third is advisory fees charged by mutual funds.

Further, until March 2023, funds were also allowed to charge a fourth additional expense of 30 basis points (bps) if they received inflows from beyond the top 30 (T-30) cities in India. However, the regulator has now asked mutual fund houses to keep the small-town-linked incentive structure in abeyance, citing the lack of a system-driven mechanism to check the misuse of this incentive structure.

T-30 refers to the top 30 geographical locations in India, and B-30 refers to the locations beyond the top 30.

Payments to distributors

Apart from the above costs, AMCs are permitted to deduct transaction charges of Rs 100 from existing investors in a mutual fund and Rs 150 from first-time investors per subscription of Rs 10,000 and above from the subscription amount paid by the investors. The amount deducted as transaction charges is paid to the distributor.

Meanwhile, mutual funds have adopted the full trail model of commission in all schemes. This means that payment of any upfront commission or upfronting of any trail commission, directly or indirectly, in cash or kind, through sponsorships, or any other route, is prohibited.

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However, upfronting of trail commission can be allowed only in cases of inflows through systematic investment plans (SIPs), as per SEBI regulations.

TER limits

Currently, the mutual fund expense ratio is fungible, meaning there is no limit on any particular type of allowed expense as long as the TER is within the prescribed limit.

A slab-based TER is applicable for various categories of schemes, such as equity, debt, hybrid, and solution-oriented funds.

While equity funds can charge up to 2.25 percent, non-equity schemes can charge up to 2 percent as the base expense ratio.

This expense ratio decreases as assets under management (AUM) increase, according to the slabs prescribed by SEBI.

Exchange-traded funds (ETFs) investing in indices and gold cannot levy more than 1 percent as base TER. A fund-of-funds (FoF) cannot charge more than 2.25 percent, including the expense ratio of the underlying equity schemes. In the case of FoFs investing in bond funds, the TER cannot exceed 2 percent including the expense ratio of the underlying schemes.

As per SEBI, the industry average TER, including additional expenses charged by the regular plan of different open-ended schemes during the financial year 2021–22, stood at 2 percent for equity schemes, 0.77 percent for debt schemes, 1.88 percent for hybrid schemes, and 0.11 percent for ETFs.

What can’t be charged

As per SEBI regulations, expenses such as penalties and fines for infractions of the law cannot be charged to the schemes of mutual funds.

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Further, interest on delayed payments to unitholders cannot be a part of TER. Expenses on investment management/general management, general administration, corporate advertising, and infrastructure costs are also outside the purview of TER.

Why TER vary

Regular plans of mutual fund schemes are sold by distributors, and the TER of these schemes factors in the commission payable along with other expenses. The TER of a direct scheme does not have this commission component and hence charges a lower TER compared to a regular plan. If you are a ‘do-it-yourself investor’ and can choose the right schemes, then you can consider investing in direct plans.

Actively managed funds charge more than passive schemes. ETFs mirroring the widely followed index – Nifty 50 – charge as low as five bps.

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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 when selecting a mutual fund scheme.

Though the expense ratio of a mutual fund scheme is important, it cannot be the sole criterion for choosing an investment, as it will not ensure better returns. Remember, a lower expense ratio in direct plans should not be the only reason to opt for a direct plan. Investing in mutual funds without doing research or having a solid plan could backfire. And your financial goals could suffer as well.