All mutual funds (MF) charge investors ‘expenses’. Capped by capital markets regulator Securities and Exchange Board of India (Sebi), equity funds can charge up to 2.5% of their weekly average net assets and debt funds up to 2.25%.

Yet there are funds that charge investors nothing, or next to nothing.

For instance, the direct plans of some liquid funds and fixed maturity plans (FMPs).

A cursory glance at the expense ratios of schemes across categories tells us that some liquid funds and FMPs have been charging between one and four basis points as expense ratio.

A basis point is one-hundredth of a percentage point.

When direct plans were introduced in January 2013, the idea was that investors who wish to invest directly with fund houses, bypassing distributors, should not be burdened with distribution costs. Such investors, according to Sebi, which made the industry launch direct plans (in addition to regular plans) for all existing schemes, should pay a lower expense ratio.

But direct plans were still meant to have an expense ratio. According to the March and September-end expense ratio figures provided by Value Research, some fund houses offer direct plans for next to nothing.

DSP BlackRock Liquidity Fund’s expense ratio as on September 2015 was 0.03%. L&T Liquid Fund’s expense ratio was 0.04%. HSBC Cash Fund, JP Morgan India Liquid Fund’s and HSBC Cash Fund’s expense ratios were 0.05%.

The direct plans of FMPs come even cheaper. There are scores of FMPs launched by HDFC Asset Management Co. Ltd whose expense ratios are just 0.01%. About 11 FMPs by L&T Investment Management Ltd have an expense ratio of just 0.02% in their direct plans.

Sebi rules state that every mutual fund plan must set aside two basis points towards investor education. Fund industry officials said a further 2-5 basis points go towards meeting registrar, transfer agent and custodian fees. Anything over that is what the fund house gets to keep.

Direct plans don’t have distributor fees as these plans are meant for investors to invest in directly. “It’s very common for liquid funds to undercut; to charge lower than what they should ideally be charging. If fund houses charge anything less than the bare minimum of two basis points, then they are paying out of their own pocket," said the head of sales of a large fund house who did not wish to be named.

Mint sent e-mails to HDFC AMC, L&T Investment Management Co Ltd and DSP BlackRock Investment Managers Ltd but did not receive any response at the time of going to print. Telephone calls made to the debt fund manager at HSBC India Asset Management Co. Ltd went unanswered.

“The Sebi formula of expense ratio just fixed the upper cap. Fund houses are allowed to charge below that," said a chief executive officer of another fund house who too did not want to be named.

To be sure, the Sebi formula is devised in such a way that as the corpus grows, the expense ratio goes down.

There’s another reason why fund house charge less on liquid funds. “Returns from liquid funds are just in the range of 7-8%. So if I charge 1% expense ratio, I am shaving off a straight 100 basis points from my returns. That’s huge. My fund could drop by a quartile in terms of rankings," said a senior fixed income fund manager of a fund house.

As on 29 December, liquid funds returned 7.20% (annualized) over a three-month period.

Consider this: a fund that stood 15th in the pecking order based on returns, if it adds 50 basis points to its expenses, its returns will drop to about 7.05%. That, according to the same table, will result in the fund dropping to 41 in the returns ranking.

“The competition in liquid funds is intense given that mostly corporate investors invest. I believe that fund houses are putting in an extra buck out of their own pocket by undercutting the expense ratios to look good in rankings," said the fixed income fund manager cited above.

Given that many fund houses also use liquid funds as a tool to also showcase higher assets under management (AUM), one solution could be to remove liquid funds’ AUM when fund houses calculate their overall asset size, said the chief executive officer of a fund house on condition of anonymity.

For investors, a low-cost option sounds good, but may not always be the best pick. Just because direct plans have a lower expense ratio doesn’t mean they are for everyone. They are meant for those who can figure out which funds to invest in on their own, without the help of a distributor, and can manage their portfolios.