Factors like money-market funds, among others affect the trend in lower expense ratio
The expense ratio is the annual fee all funds or ETFs charge their shareholders. It expresses the percentage of assets deducted each fiscal year for fund expenses like administrative, compliance, distribution, management, marketing, shareholder services, record-keeping fees and other costs. Expense ratio as a concept is applicable in almost all the managed financial products like mutual funds, Ulip, National Pension Scheme, etc.
Expense ratio is deducted from investments on daily basis by mutual funds and only after that net asset value (NAV) is published. For example, if you have invested Rs 1 lakh in a mutual fund whose expense ratio is 2% and suppose your mutual fund saw a growth of 0.5% in a day, which turn out to be Rs 500, your NAV won't be Rs 1.5 lakh.
Before that you will have to pay 2%/365 (that’s 365th part of 2% as charges, as it’s for one day, remember 365 days in a year) and that would be Rs 5.48. Hence, final value of your investment would be Rs 1 lakh+500-5.48=1,00,494.50 that’s 0.4945% increase and not 0.5%. The deducted amount might seems negligible for one day but affects the returns of the investments in long term such as 5-10 years horizon.
Factors affecting expense ratio of debt funds:
The trend in lower expense ratios can be attributed to a variety of factors, such as money market funds waiving expenses to ensure that net returns remain positive during periods of low interest rates.
In addition, expense ratios often vary inversely with fund assets, meaning that as a fund’s assets increase, its fixed costs likely represent a smaller percentage of its net assets; therefore, its expense ratio can correspondingly decrease.
The given chart shows how the performance of the same fund can change significantly due to change in expense ratio. In longer term, it is seen how the corpus value reached Rs 29.9 lakh without any expense ratio, but if the expense ratio was 2%, then despite the same performance, the corpus would be reduced to only 16.3 lakh. That’s huge deficit of 45% compared to original corpus.
Also, the highlighted part shows how low expense-ratio cases achieved the same corpus few years early than the high expense ratio scenario. You can see that with 0.5% expense ratio, Rs 16 lakh was the corpus in 26th year itself which took 30 years in case of 2% expense ratio.
PAY ATTENTION
- Factors like money-market funds, among others affect the trend in lower expense ratio
- Expense ratios also often increase or decrease inversely with fund assets
The writer is chief investment officer, LIC Mutual Fund
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Factors affecting expense ratio of debt funds:
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