Like a growing number of Indian investors, you most likely invest in Mutual Funds on a regular basis. You are also perhaps aware that Mutual Funds charge a certain percentage of their Assets under Management (AUM) for managing the fund. This expense is known as the Total Expense Ratio (TER) and it is a number regulated by SEBI. The maximum TER that funds can charge as management fees depends on the size and type of the fund, as shown below:
As of end of Aug 2019, there were 269 active equity oriented mutual fund schemes in India, with AUMs ranging from a high of 25,069cr to a low of just 0.64cr (source: www.amfiindia.com). Since fund size determines the maximum TER that can be levied by the AMC, it is important for investors to know the fund size before short-listing it. At the top of the scale of 2.25%, every Rs 1000 invested by investors can lead to a fee income of Rs 22.50 for the AMC. This is an annually recurring fee which will be deducted every year - in fact it is deducted proportionally from the NAV every day. What this also means is that if the fund returns 15% per annum before fees, the investor will only get a return of 12.75% after fees. In fact, since management fees are deducted from the NAV on a daily basis, investors will actually get much less than 12.75% on an annualized basis due to the compounding effect of the daily fees. Hence everything else being equal, a fund with a lower TER is always desirable.
A lower TER is even more desirable for debt funds whose expected annual returns are much less than equity funds. Note that as per SEBI guidelines, the maximum TER for a debt oriented fund is only 25 basis points lower than equity oriented funds in the same slab, although the returns for a debt fund can be less than half that of an equity fund over a longer duration. This means that a lower TER is critical during debt fund short-listing, since a higher TER can eat away a significant portion of the absolute returns of the fund.
What to Do
One way to get a lower TER is to always invest in mutual funds with the Direct plan option. This one action alone can reduce the TER by more than 50% compared to the Regular plan of the same fund. Consider the following table that shows the average TER for the three categories of funds for Regular and Direct plans (source: www.valueresearchonline.com)
AUM slab
(Rs cr)
|
Equity oriented schemes – max TER%
|
Debt oriented schemes – max TER%
|
0-500
|
2.25
|
2.00
|
500-750
|
2.00
|
1.75
|
750-2000
|
1.75
|
1.50
|
2000-5000
|
1.60
|
1.35
|
5000-10000
|
1.50
|
1.25
|
10000-15000
|
1.45
|
1.20
|
15000-20000
|
1.40
|
1.15
|
20000-25000
|
1.35
|
1.10
|
25000-30000
|
1.30
|
1.05
|
30000-35000
|
1.25
|
1.00
|
35000-40000
|
1.20
|
0.95
|
40000-45000
|
1.15
|
0.90
|
45000-50000
|
1.10
|
0.85
|
More than 50000
|
1.05
|
0.80
|
As of end of Aug 2019, there were 269 active equity oriented mutual fund schemes in India, with AUMs ranging from a high of 25,069cr to a low of just 0.64cr (source: www.amfiindia.com). Since fund size determines the maximum TER that can be levied by the AMC, it is important for investors to know the fund size before short-listing it. At the top of the scale of 2.25%, every Rs 1000 invested by investors can lead to a fee income of Rs 22.50 for the AMC. This is an annually recurring fee which will be deducted every year - in fact it is deducted proportionally from the NAV every day. What this also means is that if the fund returns 15% per annum before fees, the investor will only get a return of 12.75% after fees. In fact, since management fees are deducted from the NAV on a daily basis, investors will actually get much less than 12.75% on an annualized basis due to the compounding effect of the daily fees. Hence everything else being equal, a fund with a lower TER is always desirable.
A lower TER is even more desirable for debt funds whose expected annual returns are much less than equity funds. Note that as per SEBI guidelines, the maximum TER for a debt oriented fund is only 25 basis points lower than equity oriented funds in the same slab, although the returns for a debt fund can be less than half that of an equity fund over a longer duration. This means that a lower TER is critical during debt fund short-listing, since a higher TER can eat away a significant portion of the absolute returns of the fund.
What to Do
One way to get a lower TER is to always invest in mutual funds with the Direct plan option. This one action alone can reduce the TER by more than 50% compared to the Regular plan of the same fund. Consider the following table that shows the average TER for the three categories of funds for Regular and Direct plans (source: www.valueresearchonline.com)
Fund
Category
|
Regular plan average TER
|
Direct plan average TER
|
Savings in Direct plan
|
Equity
|
2.02%
|
1.22%
|
39.6%
|
Hybrid
|
1.96%
|
0.98%
|
50.0%
|
Debt
|
0.9%
|
0.42%
|
53.3%
|
Since Direct plans offer savings of more than 50% over Regular plans, it is pretty obvious that every investor should opt for them by default. The question then is how to shortlist Direct funds without the help of a Mutual Fund Distributor (MFD) since they will only offer you funds with the Regular plan. You have two choices here – the first choice is to learn to do it yourself. Apart from the pleasure of saving money you will also have the satisfaction of gaining some investing knowledge in the process. If this option is not feasible for you for any reason, then the next best option for you is to hire the services of a SEBI Registered Investment Adviser (RIA) who will charge you a part of your savings for providing his/her services. In this case you will save a little less money but will have the benefit of professional selection of funds as per your risk profile and goals as well as the facility of reaching out to an investment professional any time during the service period. Both options will save you money and have their own benefits – the choice really is yours. An informed investor is always a wiser investor!
