What is expense ratio? Does it impact the net asset value (NAV) of a mutual fund scheme? Should an investor look at it before investing?
The expense ratio is the annual fee that all mutual funds charge their unit holders. When an investor invests in a fund, she is employing the services of a fund manager through the fund company. The cost of this service is debited from the invested money regularly as fees. This ratio is expressed as a percentage of the fund value. In India, the Securities and Exchange Board of India (Sebi) has stipulated upper limits for what expense ratios can be for different types of funds (equity funds, debt funds, balanced funds, and so on).
For a regular equity fund, the expense ratio is capped at 2.5% with some leeway given for investments brought in from small towns.
The expense ratio continuously impacts the NAV of a fund. Every day, the published NAV is net of the expense ratio, i.e., the expense is debited from the fund on a daily basis and the NAV is adjusted (decreased) to reflect this debit. It should be noted that by doing it this way, an investor would pay the cost of investing in a fund in proportion to the number of days she is invested in the fund. For instance, if an investor invests in a fund for six months, then the charges incurred will be half the annual expense ratio for the fund.
Expense ratio is a factor that deserves attention since it impacts the fund’s effective return. It should also be noted that direct plans of mutual funds (available directly with fund houses) offer lower expense ratios compared to regular plans. So, a savvy investor who does not need much guidance would benefit from a lower expense ratio by investing through direct plans.
Can a mutual fund change the nature of the scheme from what is specified in the offer document?
A mutual fund can indeed change the nature of a scheme from the one specified in the offer document.
This can happen in one of two ways. It can happen through an explicit desire for a change of course by the fund manager. But more often than not, such things happen when two funds merge or when one fund takes over another. In either case, however, the fund house would be obligated to notify all unit holders in the fund and to provide an exit window to the investor in the form of a period of few weeks. During this window, an investor can exit the fund without payment of exit load.
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