Total Expense Ratio (TER)

The Total Expense Ratio (TER) is a significant indicator of the expenses associated with overseeing and running an investment fund, like a mutual fund or Exchange-Traded Fund (ETF). Calculated as a percentage of the fund’s average Assets Under Management (AUM), the TER includes all yearly expenses, including management, administrative, operating, and other costs linked to the fund’s assets. However, it does not include transaction costs and performance fees. This metric is important for investors since it directly impacts the fund’s net returns. Simply put, a higher TER leads to lower returns for investors, assuming all other factors remain constant.

TER provides investors with a clear look at a fund’s efficiency and expenses, allowing them to compare funds with knowledge. This is especially important for index funds, where reducing costs is important for maximising returns. However, it is also relevant for managed funds, where higher fees may be warranted for better performance. By understanding TER, investors can determine if they are getting their money’s worth and make more informed investment choices.

Working of Total Expense Ratio (TER)

Investors pay close attention to the size of the TER because it directly impacts their returns. The TER represents the annual expenses incurred by a fund, subtracted from the fund’s earnings. For instance, if a fund generates a 7% return but has a TER of 4%, the actual gain for investors would be reduced to around 3%.

The TER serves to cover the ongoing costs of managing a specific fund. It consolidates all the known expenses related to the fund’s operations into a single figure, typically expressed as a percentage. This figure is calculated based on the fund’s assets, which fluctuate depending on its performance.

The TER provides funds to cover various expenses related to managing, trading, and legal matters, as well as audits and general operations. The TER typically reflects those changes if a fund’s operating expenses increase or decrease. The TER is higher for actively managed funds, as they incur greater personnel costs and transaction-based fees for each trade. In contrast, automated or passive funds have lower operating costs, leading to a lower TER.

The Formula for Calculating Total Expense Ratio (TER)

The formula for calculating the Total Expense Ratio (TER) is:

(Total costs of the scheme during the period / Total Fund Assets)*100

In this equation:

• Total Fund Costs include all the fund’s annual operating expenses, such as management fees, administrative fees, audit fees, and other operational costs.
• Total Fund Assets represent the average value of the fund’s assets over the measured period.
• The result, expressed as a percentage, indicates the proportion of the fund’s assets consumed by expenses each year, providing investors with a clear indication of the cost of investing in the fund.

Total Expense Ratio (TER)

Let’s take an example to understand TER calculation:

Imagine putting your money into a mutual fund with a total value of Rs. 100 crore. This fund has various expenses, which are:

Sales and Marketing Costs: Rs. 35 lakh

Cost of Administration: Rs. 40 Lakh

Costs associated with legal and accounting services:  Rs. Rs. 30 lakh

Other operational expenses: Rs. 10 lakh

In this case, the overall costs amount to Rs. 1.15 crore (Rs. 35 lakh added to Rs. 40 lakh, which is then combined with Rs. 30 lakh and Rs. 10 lakh).

The total expense ratio for the fund will be 1.15% ( 1,15,00,000 / 100,00,00,000)

Difference Between Total Expense Ratio and Gross Expense Ratio

Total Expense Ratio (TER)	Gross Expense Ratio (GER)
Includes all annual operating expenses like management and administrative fees.	Represents all gross costs before any fee waivers or reimbursements are applied.
Reflects the actual cost to investors, showing the net expense ratio affecting returns.	Shows the fund’s full expense structure before any discounts, useful for cost comparison.
Directly affects investor returns, leading to the net costs being deducted from the fund’s assets.	Indicates potential maximum costs; may not directly impact returns due to fee adjustments.
Calculated as a percentage of the fund’s average assets, accounting for net expenses.	Calculated as a percentage of the fund’s average assets, accounting for gross costs.

Limitations of Total Expense Ratio (TER)

• The TER does not account for the transaction costs incurred by the fund when buying or selling securities. These costs can vary significantly and impact the fund’s performance, especially in funds with high portfolio turnover.
• The TER is calculated based on average fund assets over a period, which may not accurately represent the costs incurred by individual investors, especially in funds with fluctuating asset values.

Why Do Fund Houses Often Change the Total Expense Ratio (TER)?

Mutual Funds’ Total Expense Ratios (TER) can fluctuate, typically monthly or quarterly. There are two primary reasons why fund houses alter the TER of Mutual Funds: changes in Assets Under Management (AUM) and the need to maintain competitiveness in the market.

Impact of AUM Changes on Mutual Funds’ TER

AUM is the total worth of assets in a Mutual Fund’s portfolio. SEBI has made it mandatory for Mutual Funds to use AUM to determine the maximum expense ratio investors can charge. Therefore, any changes in the fund’s AUM will result in a change in the expense ratio. Although AUM changes occur daily, it is not feasible for fund houses to modify the TER of their funds daily. As a result, most fund houses adjust the TER of their schemes monthly or quarterly.

Changing TER to Maintain Competitiveness

In the world of Indian Mutual Funds, competition is fierce as fund houses vie for the attention of investors. To put it into perspective, 39 tax-saver ELSS funds, 33 large-cap funds, 28 mid-cap funds, and 30 flexible-cap funds are currently available for investors. And that’s not all, there are also Index Funds and Debt Funds that offer their own unique options.

But it is not just about the number of funds available. Performance is also an important factor. A Mutual Fund can switch to another scheme if it fails to meet investor expectations.

Since a Mutual Fund’s returns are influenced by its expenses, Fund Houses must carefully determine the total expense ratio (TER) they will charge because a high TER can hinder the fund’s assets under management (AUM) growth, potentially leading to negative AUM growth compared to other funds in the same category. Fund Houses consider this when deciding on a Mutual Fund’s TER.

Increasing Index Fund Expense Ratios

The increase in expense ratios for index funds can be attributed to several factors, despite their reputation for being cost-effective investment options. Here are some possible reasons:

• Enhanced Services and Features
• Regulatory Compliance and Reporting Requirements
• Market Expansion
• Investor Demand for Niche Indexes
• Scale and Asset Under Management (AUM)
• Marketing and Distribution Costs
• Performance Alignment