What is the Total Expense Ratio in a Mutual Fund?

TER (full form: Total Expense Ratio) is an important cost indicator in Mutual Fund investing. It captures the ongoing expenses required to manage, administer, and operate a Mutual Fund scheme. Since these expenses are charged to the scheme and reflected in the Net Asset Value (NAV), they reduce the fund’s gross performance into the net return that is actually reported.

A clear understanding of expense ratio helps comparing similar funds on cost efficiency. A higher expense ratio may eat into your returns. This blog explains the meaning of expense ratio and its impact on mutual fund schemes. 

What is Expense Ratio?

Expense ratio is an annual fee that mutual funds charge for managing a mutual fund scheme. The fee may include administrative costs, operational costs, management fees, etc. A higher expense ratio may bring down overall returns. 

How Expense Ratio Works?

The Asset Management Company (AMC) charges an expense ratio for managing a mutual fund scheme. This expense ratio is adjusted before the daily Net Asset Value (NAV) is announced. 

To maintain transparency, AMCs disclose the expense ratio of every mutual fund scheme on a monthly basis in the scheme factsheet, which is published on the AMC’s official website. 

How is Expense Ratio Calculated?

Expense ratio is commonly represented using this relationship:

Total Expense Ratio (TER) = (Total Annual Expenses ÷ Average AUM) x 100

Where

• Total Annual Expenses: The permissible costs of running the scheme (management, administration, compliance, distribution, and other operational costs).
• Average AUM: Typically, the average value of scheme assets over a period (often daily or periodic averages).

What Is Included in the Expense Ratio?

Expense ratio includes multiple components required to run a Mutual Fund scheme. The exact line items vary by fund house and category, but typical components include:

1. Investment management and advisory fees

Fees paid for portfolio management, research, and investment decision-making.

2. Administrative and operational expenses

Costs for scheme operations, accounting, reporting, technology systems, and general administration required for the day-to-day functioning of the scheme.

3. Registrar and transfer agent (RTA) costs

Costs for investor servicing functions such as unit allotment, redemption processing, transaction records, and statement generation.

4. Custody, audit, and legal expenses

Expenses related to safeguarding assets (custody), conducting audits, and meeting legal and documentation requirements.

5. Compliance and regulatory costs

Costs related to governance, compliance monitoring, regulatory reporting, and risk oversight processes.

Why Expense Ratio Awareness Matters?

Expense ratio may influence net Mutual Fund returns. It is imperative for investors to know the impact of expense ratio on their mutual fund returns.

• Understanding active and passive strategies: Actively managed funds typically involve higher operating costs, while passive funds track an index and generally have lower expense ratios due to their structure.

What Factors May Affect the Expense Ratio?

The expense ratio of a Mutual Fund is influenced by a combination of regulatory framework defined by SEBI and industry practices guided by AMFI and structural factors. The actual expense ratio applied to a scheme varies based on:

• Scheme category such as equity, debt, or hybrid, each with different permissible cost limits
• Average Assets Under Management (AUM), as larger funds may operate at lower expense ratios due to scale
• Permissible additional expenses, applied under specific conditions as allowed by SEBI regulations

Details of expense charges are transparently disclosed in Scheme Information Documents (SID), Key Information Memorandum (KIM), fund factsheets, AMC websites, and periodic TER disclosure reports.