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The expense ratio of a mutual fund scheme is the annual fee that mutual fund houses charge to the investors for managing the scheme. The exact amount is calculated by dividing the total expense of the mutual fund scheme by the value of assets.The fund house charges this fee because the management of the scheme involves various costs, including promotion cost, compliance cost, marketing cost, administrative cost, etc.As per the Securities and Exchange Board of India (SEBI) guidelines, the fund houses can charge Total Expense Ratio on the scheme, which are subject to certain maximum limit based on the value of the Asset Under Management (AUM).
| Asset Under Management (Value in Crores) | Total Exchange Ratio for Equity Schemes | Total Exchange Ratio for other schemes, except Fund of Funds, Index Funds and ETFs |
| INR 0-500 | 2.25% | 2.00% |
| INR 500-700 | 2.00% | 1.75% |
| INR 750-2,000 | 1.75% | 1.50% |
| INR 2,000-5,000 | 1.60% | 1.35% |
| INR 5,000-10,000 | 1.50% | 1.25% |
| INR 10,000-50,000 | TER is reduced by 0.05% for every increase in AUM of INR 5000 crore | TER is reduced by 0.05% for every increase in AUM of INR 5000 crore |
| More than INR 50,000 | 1.05% | 0.80% |
From the above table, it is evident that the mutual fund expense ratio is inversely proportional to the fund’s AUM. When the value of the funds’ assets is high, the expense ratio is lower, and vice-versa.
What Are Different Components of Mutual Funds Expense Ratio?
The expense ratio includes different kinds of costs incurred by the fund house, including:
- Management fee The fund managers who manage the investments invest a lot of time and energy in managing the corpus, stocks and the investor’s portfolio. They constantly keep a tab on market trends and do in-depth research about the movements to make calculated predictions on the different assets that have the potential to generate maximum returns for the investors and invest in them.
- Maintenance fee As the name suggests, the fund house incurs this cost for the maintenance of the portfolio. The maintenance activities include, keeping track of the transaction records, providing customer support to the investors, etc.
- Brokerage Regular mutual fund plans have a higher expense ratio than direct funds because the asset management companies hire financial brokers and agents for buying and selling the stocks. Thus, the commission paid to the brokers is included in the expense ratio as brokerage in a regular mutual funds scheme.
- 12B-1 This charge is usually levied for new funds that are launched in the market, and are lesser known. For its promotions among the masses and create an asset base for the fund, promotional charges are added in the expense ratio.
How to Calculate Mutual Funds Expense Ratio
Now that you are aware of the various charges that constitute the mutual funds expense ratio and the percentage of the charges, it would help you to understand how the expense ratio is calculated.While there are many ratios used to evaluate the mutual fund, experts recommend using the following basic ratios to analyse any mutual funds scheme. Here is a mutual fund expense ratio calculation example.
σ=√[Σ(x-y)² / n]
- Standard Deviation It is one of the most widely used methods for calculating the risk involved in a mutual fund. The formulate standard deviation isIn the above formula,x is each individual value, like monthly returnsy is the average of the values, like monthly returns averageN is the tenureA high standard deviation suggests higher risk in the fund and vice versa
- Turnover Ratio This ratio indicates the percentage of mutual funds’ assets that are purchased and sold in the previous financial year. For example, 50% Turnover ratio suggests that the Mutual fund has purchased or sold 50% of the average assets.A higher turnover ratio could mean that the fund manager is frequently changing investment strategies and incurring higher cost. Thus, a higher Turnover ratio is viewed as a negative factor.
- Alpha Alpha, which is also commonly referred to as Jensen’s Alpha is the degree with which the mutual fund outperforms the benchmark index. A high Alpha indicates that the fund is outperforming, whereas, a lower or negative Alpha indicates the fund’s poor performance.
- Beta Beta is an indicator of the mutual funds ’ sensitivity to the market movements. Higher the Beta, more sensitive the fund is, and it also implies higher risk and higher returns possibility.
- Sharpe Ratio This type of mutual funds expense ratio includes both risks and returns. It gives the investors a fair idea about the returns delivered by the fund compared to the risk. A high Sharpe Ratio indicates higher returns for a given risk level, and hence experts recommend looking for mutual fund schemes with higher Sharpe Ratio.
Final Word The expense ratio is an important factor for the investors as even a small difference in the expense ratio percentage can have a major impact on the net profitability.
DISCLAIMER
The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.