Sebi has cut total expense ratio for MFs: Here's what this means for you

Read for a quick lowdown on everything that you need to know about mutual funds, TER, the latest Sebi order and the order's likely impact on you as an investor

In a bid to make investing in mutual fund (MF) schemes cheaper, market regulator Securities and Exchange Board of India (Sebi) on Tuesday lowered the total expense ratio (TER) of MFs. The move is likely not only to make it easier for you to invest in MFs but also improve the returns.

 
So, should you park more money in these funds now? And if so, what will be the real benefits? Before parking your hard-earned money in this investment vehicle, it is important that you first understand what the order actually means and how you stand to benefit from it as an investor.
 
Here is a quick lowdown on everything that you need to know about mutual funds, TER, the latest Sebi order and the order’s likely impact on you.
 
What are mutual funds?
 
Mutual funds basically are a professionally managed investment vehicle where your fund manager collects money from a large pool of investors and then parks it in various securities — stocks, bonds, and several other financial instruments. Based on the kind of securities your fund manager invests in, mutual funds can be of different types — equity funds, index funds, balanced funds, etc.
 
What is total expense ratio or TER?
 
TER is a measure of total cost of managing mutual funds that investors pay for availing of the services. Fund management fees, agent commissions, registrar fees, selling and promoting expenses, all fall under the common basket of total expense ratio or annual recurring expenses.
 
You can find ‘TER of MF Scheme’ on the left side of the home page of the Association of Mutual Funds of India (Amfi) website (www.amfiindia.com). Here you get the names of all fund houses.
 
Technically, as the name suggests, TER is a ratio. It is essentially a percentage of your investment that you pay a fund every year to manage your money. For example, if you invest Rs 5,000 in a fund with an expense ratio of 1 per cent, you are paying the fund Rs 50 (one per cent of Rs 5,000) annually to manage your investment. TER is calculated by dividing the total cost of the fund by the fund's total assets.
 
Total Expense Ratio = Total fund costs/Total fund assets
 
What has Sebi ordered?
 
The regulator has capped the TER for fund houses with equity assets of up to Rs 500 billion at 1.05 per cent, against as much as 1.75 per cent earlier. Asset management companies with lower assets under management (AUM) will be allowed to charge a higher TER, based on slabs. Sebi has also said that the industry will have to move to a full “trail model” for commissions. A trailing commission is the money that you pay to the fund every year of your owning the investment. Sebi also capped the fees for exchange-traded funds (ETFs) at 1 per cent. TER now cannot exceed 1.25 per cent for equity-oriented schemes, and 1 per cent for schemes other than the equity-oriented ones.
 
Why is the move so important?
 
Since TER is charged every year, a high expense ratio over the long term could eat into your returns massively through the power of compounding. For example, Rs 1 lakh over 10 years at the rate of 15 per cent will grow to Rs 4.05 lakh. But if you consider an expense ratio of 1.5 per cent, your actual total returns would be Rs 3.55 lakh, nearly 14 per cent less than what you might have achieved without an expense ratio being charged.
 
What analysts are saying?
 
Stefan Groening, director (Investment Solutions), Sharekhan, BNP Paribas, says: "Any move that is in the interest of investors is in the interest of the industry." As costs go down, the net return of funds increases, thereby making mutual funds an even more attractive option for investors. Care should, however, be taken to ensure that costs are not lowered to an extent where the industry is unable to attract and pay for quality talent, Groening adds.
 
Amit Singh, chief executive officer, Investica, said the mutual fund customers would benefit from the changes in the fee structure and the gap between the regular and direct schemes would narrow further. But marketing spends by AMCs will take a toll, and growth of large AMCs might suffer due to these changes. This will cause a pressure on the distribution network. Investments coming from beyond top 30 cities might also be impacted due to this, as those are heavily dependent on distribution channels.