Expense Ratio – Cost to manage Mutual Funds
Ask any investor how he decides a Mutual Fund scheme before investing into it; probably the answer will come in terms of ‘returns’ rather than ‘expense ratio’ which should be the prime factor in selecting the fund. Expense Ratio is a cost to measure what investment companies require run a fund. In simple word, it is defined as the ratio of mutual fund’s expense to total net assets.
Bigger the better – not always
The SEBI regulation stipulates that the mutual fund scheme can charge up to 2.5 per cent of total net assets (up to Rs. 100 crore) in equity category which reduces further as the corpus rises. For any amount above Rs. 700 crore, a total expense of 1.75 per cent can be charged. After the ban of entry loads, it became very difficult for fund houses to float new schemes and pay to the distributors from the fund. This is more applicable to new fund houses which have floated in recent past and have been charging 2.5 per cent as the corpuses remain low.
ETFs still rule the industry – an analysis
We analyzed all the fund houses in India in terms of average expenses charged by them for their equity schemes. For equity, we considered Equity Funds (all categories), Balanced, ELSS and ETFs (other than Gold ETFs). We took the latest available expense ratios and month end corpuses for all the sorted schemes. Since some of the fund houses don’t declare month-end AUM, we considered Quarterly Average AUM for them. Based on calculation, it emerged that the fund houses having ETFs predominantly emerged as the clear winners in terms of charging the least expenses. Benchmark and recently launched Motilal Oswal Mutual Fund top the chart with least average expense ratios of 0.65 per cent and 1 per cent respectively which clearly boast that ETFs are the ideal products for long term investors with least costs.
Surprisingly, Quantum Mutual Fund having a total equity corpus of Rs. 79 crore in Equity runs the least average expense ratio (1.48%) despite having active funds only in their portfolio; as per their policy, this Mutual Fund does not pay any brokerage to distributors and promotes their schemes directly. The others in the top category are IDBI Mutual Fund (1.5%), UTI Mutual Fund (1.76%), HDFC Mutual Fund (1.84%) etc.
Fund Houses which have been fully utilizing the expense ratio cap (2.5%) are Pramerica Mutual Fund, Daiwa Mutual Fund etc. Nonetheless, some old names which have been in the industry for quite a good time still feature in the list and are not able to reduce their expenses are Escorts Mutual Fund, L&T Mutual Fund, ING Mutual Fund, DWS Mutual Fund and BNP Paribas Mutual Fund (BNP Paribas demerged from Sundaram and merged with Fortis Mutual Fund). Other fund houses charge average expense ratios in the range of 2 to 2.5 per cent.
What is the loss for investors?
Let us take an example to understand the effect of expenses on funds’ performance. For two funds A and B, if an investment of Rs. 5 lakh is done for a period of 10 years and 20 years and having expense ratio of 2.5% and 1.5% which grow at 10 per cent, the difference in maturity amount is astonishing. In 10-years and 20-years categories, the differences in returns are Rs. 4.82 lakh and Rs. 31.81 lakh respectively.
Where should an investor incline to?
The newly appointed chairman of SEBI U K Sinha rules out reintroduction of entry loads and emphasizes on increasing the retail participation in Mutual Funds. No doubt Mutual Funds can play a bigger role in doling out handsome returns and charging less in the name of expenses. Moreover, ETFs have been emerging as the best players in terms of lesser expenses. But it is still higher when compared to developed countries’ ETFs where expenses vary in the range of 0.15-0.5% only. Also, the expense ratio is one among many factors which need to be considered while choosing a mutual fund scheme. It should not be considered in isolation.
Happy Investing!
- Amar Ranu
