One Minute Guide | Total expense ratio

One of the suggestions that the Indian mutual fund (MF) industry is contemplating is to propose a hike in total expense ratio. It aims to share this with the capital market regulator, the Securities and Exchange Board of India (Sebi), to revive the interest among the investment and the distribution community towards MFs.

What is total expense ratio?

Every year, your asset management company (AMC) deducts a certain percentage of your corpus (the money that you invest in an MF scheme) to meet its various expenses. This charge is called total expense ratio. It is an annual charge on your money that your MF imposes. The expense ratio that you end up paying is used by the fund house to meet costs such as marketing and selling expenses, agent’s commissions (the trail and upfront expenses also goes from here), fee paid towards registrar and transfer agents, trustees, auditors and custodians, advertisements and so on. As per Sebi rules, equity funds can charge a maximum of 2.5%. The charges are imposed in a tiered structure. On the first Rs 100 crore, equity-oriented schemes can charge 2.5%. On the next Rs 300 crore, they can charge 2.25% and so on. As the corpus grows, the expense ratio is supposed to fall. The tier structure for debt funds is 0.25% lower than equity-oriented funds. For index and exchange-traded funds, the upper limit is 1.5%.

Suggesting fungibility

One of the things that the MF industry is contemplating is to request for fungibility. Here’s what it means. As part of the total expense ratio, AMCs also deduct 1% as AMC charges (1.25% for assets up to Rs 100 crore and 1% for assets exceeding Rs 100 crore). The problem is even though equity funds cap their total expense ratio to 2%, they cannot charge AMC fees of more than 1%, if they have already exhausted the AMC fees limit. Fungibility means removal of internal limits. And that’s what a section of the MF industry seems to be clamouring for. They claim that if fungibility is removed, they can charge more as AMC fees, as many of them say they have the legroom to move around, and still stay within the overall cap of 2.5%. Note that MFs cannot charge more than 2.5% (2.25% if it’s a debt fund) as total expense ratio; anything above that and the AMCs should bear the cost and take it on their own balance sheets.

Charge as they perform

In September 2005, Sahara Asset Management Co. Ltd launched an equity scheme with variable pricing mechanism. Called Sahara Wealth Plus Fund, it aims to charge AMC fees (the portion of total expense ratio that goes directly to AMC as their fees for managing your money) based on its performance. As per its website, it takes into account its benchmark index’s (S&P CNX 500) returns. Depending on the returns, it will charge AMC fees that is either nil, half of “maximum permissible AMC fees” or “maximum permissible AMC fees”.