Keep an eye on cost

It is low fee and hence superior performance that has made passive funds index funds and exchange traded funds or ETFs highly popular even among sophisticated institutional investors the world over. Passive funds give you the market or average rate of return. Since the number of mutual funds is so large that they virtually constitute the market or at least a sizeable portion of it,by definition half the funds must underperform the average. Throw in the fees which drags down the long-term performance of actively managed mutual funds and it is hardly surprising that about 75 per cent of actively managed funds lag behind the index over the long term. This has so far been the experience in the West. So why pay high fee for below-average long-term performance? Let us turn now to the fee structure of mutual funds.

Types of mutual fund fees

Mutual funds fees fall into two categories:

Loads. A load is an expense charged at the time of buying entry load or selling exit load the units of a mutual fund.

Annual fund operating expenses. Recurring expenses charged by asset management companies AMCs include marketing and selling expenses,brokerage and transaction cost,registrars services for transfer of units sold or redeemed,fees and expenses of trustees,audit fees,custodians fees,costs related to investor communication,cost of fund transfer from location to location,cost of providing account statements and dividend/redemption cheques and warrants,insurance premium paid by the fund,winding up costs for terminating a fund or a scheme,cost of statutory advertisements,etc.

Technically,a funds expense ratio is the percentage of its total annual operating expenses to the funds total assets.

Ceiling on charges

The Securities and Exchange Board of India Sebi has formulated guidelines regarding the maximum expense funds can charge. If actual expense exceeds the ceiling,the AMC has to bear the excess cost. The limits have been prescribed slab-wise: 2.50 per cent for the first Rs 100 crore; 2.25 per cent for the next Rs 300 crore; 2 per cent for the next Rs 300 crore; and 1.75 per cent for above Rs 700 crore.

Fund management expenses are also charged by AMCs according to Sebi guidelines. The limits for equity funds are: 1.25 per cent for the first Rs 100 crore; and 1 per cent for above Rs 100 crore.

Current charges

The expense ratio is deducted from the net asset value NAV on a daily basis. The loads,on the other hand,are charged on the amount invested or redeemed. The details of expenses and loads can be obtained from a funds prospectus.

To satisfy different investment needs,a large variety of mutual funds exist. The fees charged by them also varies widely See table. The expense ratio on exchange traded funds such as Nifty BeES 0.5 per cent and PSU Bank BeES 0.75 per cent is the lowest among mutual funds. They carry no exit or entry loads,but remember to factor in the brokerage fees since these funds have to be purchased from a stock exchange via a broker.

Remember also that load structures vary for different sets of investors. For a high net worth individual,the load structure can be different compared to the load structure for a retail investor. Differential load structure,for instance,is observed in the case of liquid schemes,where the load charged is different for retail,institutional and super-institutional plans, says Krishnan Sitaraman,director,CRISIL Fund Services.

Recent developments. Sebi has decided that no entry load shall be charged for direct applications received by AMCs,i.e. applications submitted at the AMCs branch or collection centre,or received through the internet site of the AMC,and not routed through any distributor,agent or broker. AMCs also cant levy an entry load on bonus units and on units allotted on reinvestment of dividend. Intense competition in the mutual fund industry is likely to bring down such fees further in the days to come,

adds Sitaraman.

Impact on returns. The expense charged by a scheme obviously affects its returns. If the expense ratio remains low then the returns generated are higher and vice-versa, says Lahar Bhasin,head of research at ICRA Online.

What should you do

Thus,fee should be an important criterion while selecting a mutual fund scheme. According to Dhirendra Kumar,chief executive officer,Valueresearchonline,Debt funds are fairly commoditised products. Cost should be a key criterion in the selection of these funds. Since the returns earned by these funds are low,high fee tends to have a disproportionately bigger impact on their returns. Moreover,as the saying goes,There are no Peter Lynches in debt funds. It means that a great fund manager cant bring much alpha superior returns in case of debt funds. So paying a higher fee doesnt make sense in the case of these funds.

In equities,the answer is not as straight-forward. Says Kumar: All else being equal,cheap is better in case of equity funds as well. But you should not mind paying a little higher fee for a fund that has a great performance track record.

The bottomline: all else being equal,go for a lower-cost fund. Says Sitaraman: Since expenses are charged regularly,they have an impact on the compounded returns earned by the investor over the long run. If two funds demonstrate the same performance,the only differential aspect would be their expense ratios. Hence, while making an investment decision an investor must look at expenses in conjunction with other factors like scheme performance,AMCs track record,investment philosophy,and the fund managers track record.

niti.kiranexpressindia.com