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Aarati Krishnan

WHAT is an expense ratio? It is the cost of owning a fund. It represents the percentage of a fund's assets that go towards meeting the expenses of running the fund.

The expense ratio thus comes entirely out of the fund's NAV and reduces the returns earned from its investment portfolio.

The expenses include the fund management fees, administrative costs, selling and distribution fees and costs of communicating with investors.

The expense ratio is usually expressed as a percentage of the average net assets of the fund, so that it can be directly linked to a fund's NAV.

Are there other costs to owning a fund?

Yes, there are. Apart from the expense ratio, which captures a fund's recurring expenses, funds may charge you an additional "load" for buying into or selling the fund's units. Equity funds usually charge an entry load of 1.5-2.5 per cent of the NAV; debt funds usually have no entry loads.

Similarly, funds may charge you an exit load, expressed as a percentage of the NAV, when you redeem units. Debt funds usually charge exit loads to discourage short-term investments. Funds may charge different loads, based on transaction sizes.

Entry or exit loads usually do not directly impact a fund's NAV. A newly launched fund is allowed to charge up to 6 per cent of its collections towards IPO and initial marketing expenses. This is allowed to be written off in instalments from the NAV, over a period of time.

Unlike the load structure or initial issue costs, which are disclosed upfront to you when you buy the fund, the expense ratio is a hidden cost which you will have to ferret out from the fund's financial statements.

Where can you find a fund's expense ratio?

Usually, in the statutory accounts presented by the fund houses in the financial newspapers. Fund houses are required to publish the financial statements of the funds they manage, twice a year.

These accounts include a line on "% of recurring expenses to average net assets". This is the fund's expense ratio.

The investment management fee, included in the expense ratio, is also reported separately as a percentage. If you have missed the fund's advertisement in the financial dailies, check the fund's Web site to take a look at its latest accounts.

Funds are mandated to carry their latest financial statements on their Web sites. The updated offer documents and fact-sheets of fund houses may also provide information on the expense ratio.

Can the same fund have different expense ratios?

Some fund houses have separate cost structures for the sub-options within the same fund product. Retail and institutional plans of bond funds usually have distinct expense structures.

Expense ratios and management fees may also be different for the growth and dividend options of the same product.

Is there a ceiling on the expense ratio?

SEBI regulations place a ceiling of 2.5 per cent on the annual expenses that can be charged to an equity fund and a ceiling of 2.25 per cent on the expenses charged to a debt fund.

Any expenses incurred over and above this are required to be borne by the asset management company. SEBI also stipulates a progressively lower ceiling on expenses with each addition to a fund's asset base.

For equity funds, expense ratios are capped at 2.5 per cent for the first Rs 100 crore of assets, at 2.25 per cent on the next Rs 300 crore of assets, at 2 per cent on the next Rs 300 crore of assets and at 1.75 per cent on the assets exceeding Rs 700 crore.

Each of these caps is lower by 0.25 per cent for funds that invest in debt instruments.

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