What is Expense Ratio?
Under SEBI (Mutual Funds) Regulations, 1996, Mutual Funds are permitted to incur / charge certain operating expenses for managing a mutual fund scheme – such as sales & marketing / advertising expenses, administrative expenses, transaction costs, investment management fees, registrar fees, custodian fees, audit fees – as a percentage of the fund’s daily net assets.
This is commonly referred to as ‘Expense Ratio’. In short, Expense ratio is the cost of running and managing a mutual fund which is charged to the scheme. All expenses incurred by a Mutual Fund AMC will have to be managed within the limits specified under Regulation 52 of SEBI Mutual Fund Regulations.
For actively managed equity schemes, the total expense ratio (TER) allowed under the regulations is 2.5 % for the first ₹100 crore of average weekly net assets; 2.25 % for the next ₹300 crore, 2 % for the subsequent ₹300 crore and 1.75 % for the balance AUM. For debt schemes, the expense ratio permitted is 0.25 % lower than that allowed for equity funds. Information on expense ratio applicable to a MF scheme is mentioned in the Scheme Information Document. For example, an expense ratio of 1% per annum means that each year 1% of a scheme’s total assets will be used to cover the expenses managing and operating a scheme.
In addition, mutual funds have been allowed to charge up to 30 bps more, if 30% or more of new inflows come from locations “Beyond the Top-15 (B15) cities, to widen the penetration of the mutual funds in tier - 2 and tier - 3 cities.
The expense ratio is calculated as a percentage of the Scheme’s average Net Asset Value (NAV). The daily NAV of a mutual fund is disclosed after deducting the expenses. Thus, the TER has a direct bearing on a scheme’s NAV – the lower the expense ratio of a scheme, the higher the NAV.
However, while expense ratio is important, it should be borne in mind that it is not the only criterion while selecting mutual fund scheme. A scheme with a consistently decent track record, but a higher expense ratio may be better than the one which lower expense ratio, but gives poor returns.