# Total Expense Ratio

## Key takeaways

• Total Expense Ratio (TER) is a ratio of mutual fund operating costs to fund assets, expressed as a percentage
• TER is used to compute the net-of-fees return of the fund and used by investors to assess how attractive a mutual fund is in the long-term

## What is the Total Expense Ratio?

The total expense ratio or TER is the percentage of the invested sum that is deducted for annual charges (excluding commissions) by investment funds. The investor does not get any returns on the deducted TER but does on the remaining amount. TER is expressed as a percentage of the fund’s daily NAV.

For an ETF, TER includes management fees, administrative fees, operating fees, legal fees, and other costs. However, for an ETF, TER is low compared to actively managed MFs.

## How to Calculate the Total Expense Ratio?

Total assets and total costs of a fund need to be found out for calculating expense ratio.  Financial disclosures can help in finding the total assets of a fund. It is not easy to accurately calculate the total costs for an investment fund because the total expense ratio incorporates every cost related to the investment operation like management cost, trading cost, fees, administration, and overhead cost. It is difficult to get an accurate value of each of these costs.

The components of TER make up the formula. TER of the fund is mentioned in the fund profile. In the absence of such a highlight, an investor can use the following to calculate TER:

• Total assets of the fund as mentioned in the disclosures section of the fund, which is mandatory to be furnished to the regulators
• Total expenses or costs to be incurred by the fund, which is mentioned in the prospectus. However, the costs may be mentioned separately instead of an aggregate. An investor may have to study the prospectus thoroughly to capture all the costs so as to not compromise accuracy

## Formula of Total Expense Ratio

Total expense ratio can be calculated using the following formula:

Total expense ratio = Total fund costs/ Total fund assets

## What are the operating costs of the fund?

Two types of costs are associated with the management of the fund: Direct costs and Overheads

Direct costs are financial obligations of the fund directly attributable to the operation of the fund. Direct costs of the fund may arise in the form of personnel compensation, brokerage fees, and accounting fees. Fundholder communication, record-keeping, and custodial services also incur costs. Direct costs are higher for an actively-managed fund.

Overheads are not necessary and form a low percentage of TER. Overhead costs arise in the form of rental fees for operational space and other utilities for the fund house.

Components:

• Management Fees
• Maintenance Costs
• Marketing and Distribution Fees
• Brokerage Costs

## What does Total Expense Ratio represent?

Total expense ratio is an important parameter for the investors as the costs that it includes is deducted from the fund thus impacting their returns.

For example, if an investment fund gives a 7% return and has a total expense ratio of 2%, the expected gain is diminished to about 5%.

TER is typically stated in annual terms. In that case, TER is charged every year and lowers the fund returns by the stated percentage.

Total expense ratio gives a way to cover the annual cost of a fund. It expresses all the operational costs of a fund with a single number and divides it with total assets. This implies that the amount given as TER depends upon a particular fund’s success.

The funds provided through TER are utilized to support the trading, legal, management fees, and other operating expenses. Many investors get confused between TER and management fees.

Management fees are a component of TER and are not charged separately.

## Difference between Total Expense Ratio and Gross Expense Ratio

Gross Expense Ratio is an aggregate of all the fees and costs charged to the fund. However, a fund may decide to reimburse, waive, or recover a portion of the fund’s costs. A new fund offer may be accompanied by such benefits to establishing an investor base.

Net Expense Ratio for the fund that is charged to the investors is based on expenses after any reimbursements and waivers. However, the gross component of the fund may reduce with time.

## Impact of TER on fund return

TER is significant when the fund is being assessed for long-term investment. Total expenses charged eat away a chunk of the actual returns of the fund. Higher expense ratio does not reflect the fund’s ability to create superior returns. Therefore, a higher TER does not guarantee better performance.

Actively-managed funds charge more than passively-managed funds. Actively-managed portfolios also have a high-security turnover due to greater portfolio churning. Therefore, the management of such a fund is bound to cost more.

A 5 percent return after 2 percent TER can affect the ending value of the investment considerably over a long investment horizon.

 Type of Return Percentage Ending Value of Rs 50,000 after 10 years Actual Return of the Fund 8.00% 107,946 Total Expense Ratio (2.50%) – Net Return of the Fund 5.50% 85,407

Rs 50,000 more than doubles at the actual rate of return of the fund in 10 years. However, with the TER in the picture, the ending value of the investment is only 79 percent of what it would have been without TER.

The effect of TER is amplified with a higher amount of investment. When compounding takes over in an investment portfolio, a single percentage point can make or break the appeal of a fund.

 Type of Fund Average Total Expense Ratio Ending Value of Rs 1,00,000 (Rs) Profit on investment (Rs) Active: Regular Mutual Fund 2% 1,10,000 10,000 Direct Mutual Fund 1.25% 1,10,750 10,750 Passive: Index Fund 0.75% 1,11,250 11,250 ETFs 0.25% 1,11,750 11,750

## Expense Ratio prescribed by SEBI

A mutual fund can charge a maximum of 2.5 percent in India as per SEBI norms.

The following slab system is followed for actively-managed equity schemes:

 The portion of Average Weekly Net Assets TER (%) Rs 100 crore 2.5 Rs 250 crore 2.25 Rs 300 crore 2 Balance AUM 1.75

The expense ratio for debt funds across all slabs has to be 0.25 percent lower than the prescribed limits for equity schemes.

Mutual funds are permitted to charge an additional 0.30 percent (not exceeding the max limit of 2.5 percent) if 30 percent of the fund inflows come from locations other than B15 cities.

## Limitations of the Total Expense Ratio

Total expense ratio aims at including all the costs that an investor may be expected to incur. But still, there are many costs, mainly those which are paid only once, may not be incorporated like stockbroker fees, commission, annual advisor fees, and securities transfer act.