Why TER is an important ratio while selecting a mutual fund scheme

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Asset Management Companies (AMCs) are allowed to charge operating costs for managing or executing mutual fund schemes. Sales and marketing charges, administrative costs, transaction costs, investment management fees, registrar fees, custodian fees, and audit fees are all examples of these costs. These costs are frequently referred to as the ‘Expense Ratio.’ Simply defined the Total Expense Ratio (TER) is the fees charged by the AMCs to manage a scheme which is expressed as a percentage of the assets managed by the mutual fund manager.

How does TER impact investor returns?

As the amount depends on the assets under management, a high expense ratio does not always imply low returns. However, keeping an eye on the TER is critical because it has a direct impact on the investment’s Net Asset Value (NAV).

As a mutual fund investor, one should compare the TER of several funds to verify that the cost does not surpass the benefits of the mutual fund. For example, if a mutual fund has a TER of 2% and produces a profit of 17%, your total returns on investment will be 15%. A lower TER could indicate a better profit margin.

According to Securities and Exchange Board of India (SEBI) rules, TER for actively managed equity-oriented schemes as per regulations is 2.25 % for the first Rs 500 crore of daily net assets under management (AUM); 2% for the next Rs 250 crore, 1.75% for the next Rs 1,250 crore and 1.60 % for the next Rs 3,000 crore.

When it comes to the debt schemes, the expense ratio permitted is 2% on the first Rs 500 crore assets under management which is lower than that allowed for equity funds.

That said, to promote transparency in expenses, reduce portfolio churning and misselling in mutual fund (MF) schemes, SEBI has asked mutual funds and AMCs that commission should be charged to the scheme as ‘commissions’ and should also account for computing the TER differential if any between regular and direct plan in each scheme.

Further investors should know that additional TER can be charged up to 30 basis points on daily net assets of the scheme based on inflows from beyond top 30 cities subject to certain conditions. Also, according to SEBI regulations, AMCs are required to disclose the TER of all schemes on a daily basis on their websites as well as on the Association of Mutual Funds in India’s website (AMFI).