Total Expense Ratio (TER) in Mutual Funds

 

The Total Expense Ratio (TER) is a crucial metric for investors to evaluate the cost-effectiveness of mutual fund schemes. It encompasses all operating expenses incurred by the mutual fund for managing the scheme. Here’s a detailed explanation of what TER is, its components, and its implications for investors.

What Is Total Expense Ratio (TER)?

Definition: Total Expense Ratio (TER) represents the percentage of a mutual fund's assets that is used to cover operating expenses. These expenses include a range of costs associated with running the fund, such as management fees, administrative expenses, transaction costs, and other operational costs.

Components of TER:

• Investment Management Fees: Fees paid to fund managers for managing the fund’s investments.
• Administrative Expenses: Costs related to the day-to-day operations of the fund.
• Sales and Marketing Costs: Expenses incurred for promoting and selling the fund.
• Registrar Fees: Costs associated with record-keeping and shareholder services.
• Custodian Fees: Fees for the safekeeping of the fund’s assets.
• Audit Fees: Costs for auditing the fund’s financial statements.

Calculation of TER:

TER is calculated as a percentage of the mutual fund’s average daily net assets. The formula is:

$\text{TER}=\left(\frac{\text{Total Expenses}}{\text{Average Net Assets}}\right)\times 100$

• Total Expenses: Sum of all operating expenses of the fund.
• Average Net Assets: Average value of the fund’s assets over a specified period.

Impact on NAV: The TER directly affects the Net Asset Value (NAV) of a mutual fund. Higher expenses reduce the NAV, while lower expenses help in maintaining a higher NAV. Hence, the TER is a significant factor to consider when selecting a mutual fund, as it impacts the fund’s overall performance and investor returns.

SEBI Regulations on TER:

Under SEBI (Mutual Funds) Regulations, 1996, mutual funds are permitted to charge operating expenses, but these are capped by regulatory limits. As of April 1, 2020, SEBI revised the TER limits based on the Assets Under Management (AUM) for different types of funds:

For Equity Funds:

• On the first ₹500 crores: 2.25%
• On the next ₹250 crores: 2.00%
• On the next ₹1,250 crores: 1.75%
• On the next ₹3,000 crores: 1.60%
• On the next ₹5,000 crores: 1.50%
• On the next ₹40,000 crores: Reduction of 0.05% for every increase of ₹5,000 crores or part thereof.
• Above ₹50,000 crores: 1.05%

For Debt Funds:

• On the first ₹500 crores: 2.00%
• On the next ₹250 crores: 1.75%
• On the next ₹1,250 crores: 1.50%
• On the next ₹3,000 crores: 1.35%
• On the next ₹5,000 crores: 1.25%
• On the next ₹40,000 crores: Reduction of 0.05% for every increase of ₹5,000 crores or part thereof.
• Above ₹50,000 crores: 0.80%

Additional Charges: Mutual funds can charge up to an additional 30 basis points (bps) if new inflows from retail investors from beyond top 30 cities (B30 cities) constitute:

• At least 30% of gross new inflows in the scheme, or
• 15% of the average assets under management (year-to-date) of the scheme, whichever is higher.

This provision is intended to encourage inflows from tier-2 and tier-3 cities.

Why TER Matters:

1. Cost Efficiency: A lower TER means lower costs for the investor, which can contribute to better net returns. Conversely, higher TERs reduce the returns to investors.

2. Comparison Tool: TER allows investors to compare the cost structures of different mutual funds and choose the most cost-effective option.

3. Transparency: SEBI regulations require mutual funds to disclose the TER on a daily basis, ensuring transparency and enabling investors to make informed decisions.

Disclosure Requirements:

Mutual funds are mandated to disclose the TER of all their schemes daily on their websites as well as on the Association of Mutual Funds in India (AMFI) website. This regular disclosure ensures that investors have up-to-date information regarding the costs associated with their investments.

Conclusion

The Total Expense Ratio (TER) is a critical factor for mutual fund investors, influencing both the cost of investment and the potential returns. By understanding the TER and its components, investors can make more informed choices, balancing cost with expected returns. Regularly reviewing the TER of mutual funds and comparing it with other options helps in optimizing investment decisions and enhancing overall investment efficiency.