What is Expense Ratio?

Expense Ratio is the annual fee charged by the asset management company for the management of funds. The expense ratio is a particular percentage of funds that is to be paid to the fund manager and it varies from fund to fund. Sometimes even when two funds have similar features and growth rates the deciding factor for net returns is this expense ratio. For any investor, the expense ratio is like the fees that have to be paid to AMC to hold their own funds.

Every business model has certain ways of making revenues and so do these asset management companies, they charge fund management fees for managing funds on behalf of their investors. Asset management companies have the overall objective of maximizing the returns to their investors and to do so they invest a handsome amount in hiring workforce like fund managers, fund analysts, heavy investment in advertisements & awareness, they even hire credit rating agencies, auditors, and even have to pay for government duties and taxes. In order to service all these financial commitments they charge their investors.

Also, SEBI (Securities and Exchange Board of India) in the interest of investors, has instructed the AMCs about the maximum expense ratio which can be charged from the investors to ensure there is no exploitation of investors and there are equitable and adequate financial resources available for AMC’s to administer funds.

Key takeaways from the Expense Ratio:

• They are charged at some fixed percentage of the total invested fund and they differ from fund to fund.
• The expense ratio helps asset management companies to service their fund management expenses. Examples can be to pay fund managers, to pay credit rating agencies, to pay experts, etc.
• A lower expense ratio will increase the return on the invested amount, and a higher expense ratio will lower the returns.
• The expense ratio is also dependent upon the total assets under management by the AMC, the higher the AUM lower the expense ratio as the expenses will be met from larger assets and similarly, lower AUM will lead to higher expense ratio.
• SEBI has imposed restrictions on the expense ratio and has directed that maximum 2.5% expense ratio can be charged depending upon the fund.