What is Total Expense Ratio? All you need to know

Mutual fund management attracts a number of expenses. A fund company has to incur a variety of costs for the management of investors’ funds that comes in the form of management cost, buying, and selling, promotions, commissions, etc. All these expenses form Total Expense Ratio or TER. 

TER Meaning in Mutual Fund

Total Expense Ratio in Mutual Fund is the total cost of managing a fund expressed per unit. It compromises all the costs incurred by the fund management house. TER is a ratio (expressed in percentage) of the total annual cost and the fund’s total asset averaged over that year. TER is important for investors as it affects the net asset value and subsequently the return on investment.

What is TER in Mutual Fund

Expenses Associated With Managing Mutual Fund As said, TER is the measure of all the expenses incurred in running a mutual fund scheme. 

The expenses include: - 

• Management Fees: This comprises the majority of the proportion of TER. It includes fund manager(s) salaries, research fees, etc.
• Brokerage and Taxes: Costs incurred while buying and selling of stocks. This includes the brokerage fees, taxes, etc. - 
• Additional Fees: Fees paid to the trustees, custodians, registrar, and transfer agents, asset management company, legal and consultancy fees, etc. -
• Other Expenses: Costs incurred in marketing, promotion, sales, rent, electricity, etc. 

Calculation of TER

TER is calculated using the following formula: 

Total Expense Ratio (TER): Total costs incurred in managing the scheme during the period/total fund assets) x 100

In mathematical terms, TER shows the cost of running a mutual fund scheme with respect to the total value of assets under management. TER is usually expressed as an annual percentage. Since the value of open-ended funds assets changes on a daily basis, the TER is accounted for in the scheme NAV (Net Asset Value) on every business day. 

Importance of TER For Investors: Although almost all mutual fund schemes come with a nominal TER and any change in its value is not highly significant, investors still consider it an important factor for gauging investment returns. 

A fund’s net value is reported only after deducting TER on a daily basis. For example, if a mutual fund scheme is offering 20% returns and the TER is 2%, the net return comes down to 18%. An increase in expenses of managing a fund scheme also increases the TER. This decreases the net value of the assets. Similarly, a decrease in TER increases the net value of the assets. 

As an investor, you should compare the TER of different mutual fund schemes while building your portfolio. It is necessary to ensure that the TER does not outweigh the average returns the mutual fund scheme is offering. Actively managed mutual funds have higher TER than passively managed funds as the former requires comparatively a lot more management than the latter. 

SEBI Limit on TER The Security and Exchange Board of India (SEBI) has put an upper cap on TER that any mutual fund company can charge from investors. Regulation 52 of SEBI Mutual Fund Regulations, which came into force on April 1, 2020, states the TER of various Base TER at the scheme level →

Source: SEBI, Mutual funds schemes can charge costs and expenses, including GST on management fees, brokerage and transaction costs, B-30 incentives etc.

Let us now calculate the TER with an example: An equity mutual fund house has Rs 1000 crores of total assets under management. Rs 7.5 Crores per annum goes on administrative expenses and Rs 8.5 Crores on the payment of management fees. Let’s say the company incurs Rs 4 Crores in other expenses. 

The total expense ratio would be as follows: Total Expenses = Administrative costs + Management fees + Other expenses ` `= Rs 7,50,00,000 + Rs 8,50,00,000 + Rs 4,00,00,000 = Rs 20,00,00,000 

TER = Total Expenses / Total Assets = Rs 20,00,00,000 / Rs 10,00,00,00,000 = 0.02 or 2% of investment ## 

Changes in TER 

TER changes periodically, mostly on a monthly or quarterly basis. Besides the fundamental costs, mutual fund companies also have to change TER in the following cases: -

Change in AUM As we have seen that SEBI has put an upper cap on TER for different AUM levels(Assets Under Management), a change in AUM of a mutual fund scheme also results in a respective change in the TER.

For example, take the case of an equity mutual fund scheme ‘X’ whose AUM is Rs 500 Crores and the TER is 2.10%. Now, if the AUM increases by Rs 250 Crores, the TER must be equal to or below 1.75% (limit set by SEBI). 

On the other hand, if the AUM of an equity mutual fund scheme ‘Y’ is Rs 800 Crores with TER 1.7% decreases to Rs 400 Crores, the mutual fund company can increase the TER up to 2.25%. 

TER Change to Stay Competitive 

There is a pool of mutual fund schemes out there in the market, numerous under each category as well. Hence, an investor considers TER as an important factor when it comes to picking up a few out of all. Mutual fund companies know the same and try to keep their TER as competitive as possible in order to win over as many investors as possible. TER is an important factor for investors who want to invest in mutual funds. It affects the net asset value and subsequently the returns from any mutual fund scheme. The above-compiled information on TER will help you choose the right mutual funds and maximize returns by a fair margin.