Expense ratio, or the expense a mutual fund house incurs to operate a fund, is a charge all investors must bear. Although this may not seem like a huge liability to you, it is these charges on which mutual fund houses heavily bank their profits, irrespective of the profitability of their equity schemes. The expense ratio which varies from 1.75%-2.5% according to the fund house, have translated into big bucks for as much as Rs. 640 crore for the top 5 mutual funds houses in the country.
Equity funds are permitted to charge an expense ratio of almost 2.5% of their fund value annually from investors. The quantum of this charge depends heavily on the asset base. The manner in which fund houses calculate this charge is simple: a fund can charge as much as 2.50% for the first Rs. 100 crore of its assets, 2.25% for the next Rs. 300 crore, 2% for the next Rs. 300 crore and 1.75% for all amounts above that, thus depicting a descending trend of charge. While the expense ratio is deducted by fund houses from investors as a charge for marketing and custodian expenses, registrar and audit fees, postage, trial commissions, and the yearly process of fund management, it is not charged on one go, but is deducted on a daily basis from the net asset value of the fund. When a fund outperforms over the benchmark index, the expense ratio it deducts is quite justifiable. However, it is surprising to note that more than half of the popular and actively managed funds underperformed their benchmark indices over the last period of 5 years. This depressing trend could especially be noted in the case of large-cap funds and the lack of operability of prudence by fund managers, who made the wrong choice in fund investments. Thus, such funds do not deserve the expense ratio they are charging. Most investors aren’t even aware of the amount of expense ratio charged against their fund, displaying carelessness on their part. This must be avoided as small charges like expense ratios affect their overall manner in a large way.
While fund houses have to charge the expense ratio to meet their expenses and run their business profitably, it also serves as their sole source of income with the deduction of entry loads. While the Securities and Exchange Board of India has made a move to remove the burden of entry loads from the shoulders of investors, it has failed to devise any strategy for the purpose of expense ratio, which has to borne by an investor on a regular basis.
As a prudent investor you need to evaluate all the expenses involved in particular fund that you are looking forward to invest in, and understand what will be the net returns that you will be benefited with once the tenor is completed. Also it is important to factor in the exit loads if in case you need to withdraw your funds prematurely. To avoid such unforeseen circumstances, most financial advisors urge investors to stash away certain percentage of funds in Savings Bank accounts which can help during phases of immediate financial requirement. Opting for a personal loan, although is easy to get, is complicated a process when it comes to repayment. If the loan is taken from private money lenders, matters can become all the more serious.
Summarizing, make sure that you review the fund and the fund manager before deciding to invest. In case of market fluctuations, only during cases of adverse reactions in the equities sector, you can choose to withdraw your funds after discussing the pros and cons of the decision with your fund manager. Otherwise stay put and wait till the market evens out.