Explained: Meaning & Significance of Total Expense Ratio

What is a TER?

TER full form in mutual fund is Total Expense Ratio. As the name suggests, the total expense ratio (TER) is the total cost of managing and operating a scheme of a mutual fund. The mutual fund expense ratio includes costs such as management fees, brokerage costs, legal costs, auditor fees, fees paid to registrar and transfer agents, custodians, trustees and other operational expenses etc. Now that we know what a TER is, let's understand it in more detail.

Total Expense Ratio (TER) Calculation

Total Expense Ratio = (Total costs of the scheme during the period/Total Fund Assets) * 100

TER in mutual funds is typically expressed as an annualized percentage of the fund's assets.

For instance, if an investor invests Rs 1,000 in a mutual fund scheme with an expense ratio of 1.25%, then per day cost would be approximately 0.0034%, which will be deducted from the investment amount each day till the time investor stay invested. 

Here, it is important to note that the expense ratio levied differs from one mutual fund house to another, and the fees are not levied separately but are deducted from the investment value itself. That is why investors must know the mutual fund expense ratio charged; the lower the TER, the lower will be the deduction from the investment amount. 

What does TER in mutual funds mean?

What is TER meaning? Asset management companies (AMCs) incur a slew of expenses and costs while managing schemes for investors. To effectively make an investment decision, investors must know all the costs included in Total Expense Ratio (TER).

TERs of mutual funds can fluctuate. If a fund's TER decreases, the higher the possible return is. If it increases consistently, it affects returns. It is pertinent to note that TER is incurred irrespective of whether a scheme has generated a return for its unitholders or not.

Where to find TER details?

• Maximum TER of a scheme disclosed in scheme documents like Scheme Information Documents (SID) and Key Information Documents (KIM).
• Fact sheets 
• On a daily basis, disclosure of TER in mutual funds has been made on the website of the Asset Management Companies or on the Association of Mutual Funds of India (AMFI) website.

In what ways does the mutual fund expense ratio impact returns?

A fund's TER represents a percentage of the total investments in assets; consequently, they can impact a particular investor's returns.TER is dependent on the fund management style. Usually, people will find a difference in TER for active and passive funds. As passive funds generally replicate an index, TER is lower, whereas, in active funds, TER is generally higher due to active management and costs involved in running the scheme.Generally, the lower the TER, the higher the possible return, and the lower the deduction of fees will be. However, high mutual fund expense ratios are not necessarily associated with low returns since the amount of money determines the size under management. 

The easiest way to invest in mutual fund is through direct plan of a mutual fund scheme which has a lower expense ratio than the regular plan of the scheme. While monitoring the TER in mutual funds can be challenging, it is essential to do so because it is a factor that directly impacts the Net Asset Value (NAV) of the investments. It can help investors to select which mutual fund house to invest in. Comparing the TER on different mutual funds will help to ensure that the mutual fund's cost does not outweigh its benefits. 

Components of TER:

Under SEBI (Mutual Funds) Regulations, 1996, Mutual Funds are permitted to charge certain operating expenses for managing a mutual fund scheme. Investment and Advisory Fees are charged to the scheme by the AMC. 

Recurring Expenses: in addition to the investment and advisory fee, the AMC may charge the mutual fund scheme with recurring expenses some of these include: 

• marketing and selling expenses, including agents' commission, if any 
• brokerage and transaction cost 
• registrar services for transfer of units sold or redeemed 
• fees and expenses of trustees 
• audit fees
• custodian fees 
• costs related to investor communication 
• costs of fund transfer from location to location 

What are the expense ratio limits?

The Securities and Exchange Board of India has levied some limits on the various types of mutual funds when it comes to the expense ratio - Effective from April 1, 2020, SEBI has revised the TER limit as follows:

In case of open ended schemes:

In case of Index Fund scheme or Exchange Traded Fund: in case of an index fund scheme or exchange-traded fund, the total expense ratio of the scheme, including the investment and advisory fees, shall not exceed 1.00 per cent of the daily net assets. 

In the case of close-ended schemes and interval schemes, (i) the total expense ratio of an equity-oriented scheme shall not exceed 1.25 per cent of the daily net assets of the scheme. (ii) the total expense ratio of close-ended and interval scheme(s) other than schemes specified above shall not exceed 1.00 per cent of the daily net assets of the scheme.

In the case of a Fund of Funds investing in liquid schemes, index fund schemes and exchange-traded funds, the total expense ratio of the scheme, including a weighted average of the total expense ratio levied by the underlying scheme(s), shall not exceed 1.00 per cent of the daily net assets of the scheme.

In the case of Fund of Funds investing a minimum of sixty-five per cent of assets under management in equity-oriented schemes as per the scheme information document, the total expense ratio of the scheme, including a weighted average of the total expense ratio levied by the underlying scheme(s) shall not exceed 2.25 per cent of the daily net assets of the scheme. Fund of Funds investing in schemes other than as specified above, the total expense ratio of the scheme, including a weighted average of the total expense ratio levied by the underlying scheme(s), shall not exceed 2.00 per cent of the daily net assets of the scheme.

Provided that the total expense ratio to be charged over and above the weighted average of the total expense ratio of the underlying scheme shall not exceed two times the weighted average of the total expense ratio levied by the underlying scheme(s), subject to the overall ceilings as stated above.

In addition, mutual funds are allowed to charge additional expenses as defined in SEBI (Mutual Funds) Regulations 1996.

Source: SEBI (Mutual Funds) Regulations 1996 & AMFI India

Conclusion

The blog has detailed the TER meaning and significance. Choosing a mutual fund scheme that has a low expense ratio is an important aspect to consider. However, many financial experts believe that the expense ratio should always be considered along with other factors when deciding to invest. It is essential to assess the track record and consistency of returns of a mutual fund.

FAQs:

1. How does TER in mutual funds differ between regular and direct plans?

The Direct Plan can have a lower expense ratio compared to the Regular Plan due to the absence of any distributor or agent involvement, thus leading to a lower TER. 

2. Does a higher AUM lead to lower TER in mutual funds?

Going by the limits set by SEBI, the higher the AUM of the scheme lower is the applicable TER limit. 

3. What happens if the expense ratio is high?

Generally, a high TER could mean a higher cost of investment, which can be deducted from the returns generated from the scheme. However, investors need to note that it is one of the factors and not the single factor while choosing a mutual fund scheme. 

 

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