Understanding Total Expense Ratio: TER in Mutual Fund

What is Total Expense Ratio?

TER in Mutual Fund: The Total Expense Ratio (TER) is the annual fee charged by mutual funds to manage investments. It encompasses various costs, including management fees, administrative expenses, marketing, and distribution costs. TER is expressed as a percentage of the fund’s average assets under management (AUM).

Components of TER in Mutual Fund

1. Management Fees: Fees paid to the fund manager for managing the investment portfolio.
2. Administrative Expenses: Costs related to administrative tasks such as record-keeping and compliance.
3. Marketing and Distribution Costs: Expenses for promoting and distributing the fund, including commissions paid to brokers.
4. Custodian Fees: Fees for safekeeping the fund’s assets.
5. Other Expenses: Miscellaneous costs, such as audit fees and legal expenses.

SEBI Regulations on TER

The Securities and Exchange Board of India (SEBI) has set specific limits on TER to protect investors from excessive charges. These limits vary based on the type and size of the fund:

Equity Funds:

• For equity-oriented schemes, the maximum TER is:
  • 2.25% for the first Rs. 500 crore of AUM.
  • 2.00% for the next Rs. 250 crore of AUM.
  • 1.75% for the next Rs. 1,250 crore of AUM.
  • 1.50% for the next Rs. 3,000 crore of AUM.
  • 1.25% for the next Rs. 5,000 crore of AUM.
  • 1.00% for the balance AUM.

Debt Funds:

• For debt-oriented schemes, the maximum TER is:
  • 2.00% for the first Rs. 500 crore of AUM.
  • 1.75% for the next Rs. 250 crore of AUM.
  • 1.50% for the next Rs. 1,250 crore of AUM.
  • 1.35% for the next Rs. 3,000 crore of AUM.
  • 1.25% for the next Rs. 5,000 crore of AUM.
  • 1.00% for the balance AUM.

Other Schemes:

• For other schemes like index funds and ETFs, the TER limits are generally lower, reflecting their lower management costs.

Importance of TER for Investors

1. Impact on Returns: TER reduces the overall returns of the mutual fund. Lower TER means higher net returns for investors.
2. Cost Comparison: TER allows investors to compare the cost structures of different funds, helping them choose cost-effective options.
3. Transparency: TER provides transparency about the expenses incurred by the fund, enabling informed investment decisions.

Calculating TER in Mutual Fund

TER is calculated using the following formula:

TER = (Total Annual Fund Costs ​/ Average AUM) × 100

Types of Funds and TER

1. Active Funds: These funds are actively managed and generally have higher TER due to the costs associated with active management.
2. Passive Funds (Index Funds/ETFs): These funds track a specific index and have lower TER due to minimal management costs.

Strategies to Minimize TER Impact

1. Opt for Passive Funds: Index funds and ETFs usually have lower TER compared to actively managed funds.
2. Consider Direct Plans: Direct plans of mutual funds have lower TER since they do not incur distribution fees.
3. Compare TERs: Always compare the TER of similar funds before investing to ensure you are getting the best value.

Conclusion

Understanding TER is essential for mutual fund investors in India as it directly affects their net returns. By being aware of the TER and its components, comparing TERs across similar funds, and considering options like passive funds and direct plans, investors can make more informed and cost-effective investment decisions.