Expense ratio: Shun active funds with high costs, inconsistent performance

A higher expense means a larger portion of the return goes to the asset management company

The expense ratios of several equity mutual funds have increased between September 2024 and March 2025, according to media reports. Investors should avoid knee-jerk reactions and respond to changes after proper thought.

 

Why are fees increasing

 

Total expense ratio (TER) is calculated by dividing the expense incurred on a fund by its assets under management. “AUMs of many funds have declined due to the market correction, but the expense incurred on them has remained unchanged, hence TERs are showing an increase,” says Alekh Yadav, head of investment product, Sanctum Wealth.

 

In some cases, TERs may have increased despite an increase in AUM. “Fund houses sometimes increase their price because of rising costs. And sometimes they do so because there is an opportunity to increase their profits,” says Manoj Trivedi, director of strategy, Maxiom Wealth.

 

While the Securities and Exchange Board of India (Sebi) has imposed caps based on fund size, many funds operate below the ceiling, allowing them to raise charges.

 

Investor awareness about expenses is usually limited. “Many regular plan customers are not clued in about fees,” says Avinash Luthria, Sebi-registered investment adviser and founder of Fiduciaries.

 

Monitor and benchmark TERs

 

A higher TER means a larger portion of the return goes to the AMC, leaving less for the investor, unless compensated by higher returns. 

 

Fund houses are required to notify investors by email whenever the TER changes. Luthria says that investors should also check the consolidated account statements from National Securities Depository Limited and Central Depository Services Limited in March and September, where TERs are mentioned.

 

A fund’s TER should be benchmarked against its category average. “Compare a fund’s TER with peers in the same category,” says Yadav.

 

Do not focus solely on the increase. “See whether the new fee is okay compared to the other options available within the category,” says Luthria.

 

Lenient with active, strict with passive

 

Some experts argue that expense ratios matter less in active funds. “Investors should be guided more by the returns of the fund, which are calculated after deducting the TER, and not be bothered much about whether the TER is high or low,” says Trivedi.

 

A high TER should not, however, be accompanied by poor returns. “Switch out of an active fund if there is consistent underperformance,” says Yadav. According to him, other reasons for switching could be a change in style of fund management, or if the fund manager has changed, and your assessment indicates the new one may not be as capable. 

 

Cost-conscious investors in active funds may go for larger schemes. “In these schemes, the Sebi’s ceilings work to control the fee,” says Luthria.

 

Be cautious about costs in sector and thematic funds. “Many of those funds tend to have high fees,” says Luthria.

 

Strict monitoring is also called for in passive funds, which do not have the potential to outperform. “The TER becomes extremely important in these funds,” says Yadav.

 

Finally, small fee hikes are not a sufficient reason to exit. “There is no guarantee the next fund house you move to will not hike its fees. Only if the hike is egregious should you consider switching,” says Luthria.

 

Remember that switching carries a cost. “Switching funds has tax implications: 12.5 per cent if the fund was held for more than one year and 20 per cent if held for less than one year,” says Yadav.

 

Why costs matter

 

Fund returns can fluctuate, but costs remain constant

 

Expense ratio does not come down in the years when a mutual fund underperforms

 

Studies show that a high percentage of active funds across categories do not beat their benchmarks over 10 years

 

As markets become more efficient, the ability to beat benchmarks will erode