TER quite simply is ‘Total Expense Ratio.’ It is the ratio of:
All the expenses charged by a mutual fund to its investors/Average assets under management of the fund.
In other words, it is the percentage of your money that the fund management company takes as a fee. According to SEBI rules, this is capped at 2.5% for equity funds and 2.25% for debt funds. However, in practice, many funds charge lower TERs than these caps. As a result, they are allowed to increase or decrease the TER charged so long as it is within the SEBI limit.
How TER works
Mutual funds fees and expenses are currently capped by SEBI as a proportion of their weekly average assets under management or AUM. The cap is 2.5% for equity funds and 2.25% for debt funds. This cap gets more stringent, as the AUM of the fund grows bigger.
Assets under Management
Equity Funds Cap
Debt Funds Cap
First Rs 100 crore
Next Rs 300 crore
Next Rs 300 crore
A lower expense ratio is charged by the direct plans of funds than regular plans because they do not include distributor commissions. Direct plan expense ratios are typically 1% lower for equity funds and 0.5% lower for debt funds than their regular counterparts.
On top of this amount, mutual funds were earlier allowed to charge 0.2% in lieu of exit load and 0.3% in the case of inflows from outside the top 15 cities exceeded certain threshold amounts.
The 0.2% charge was introduced because SEBI had previously directed that money collected from exit loads be credited to the mutual fund rather than going to the fund house. In other words, the remaining investors of a fund get the benefit of the charge paid by those who are exiting too soon. To compensate mutual funds for the loss of revenue due to this previous rule change, SEBI allowed them to charge 0.20% over and above the cap of 2.5%/2.25%. However, this has recently been reduced to just 0.05%.
Mutual funds which received more than 15% of their AUM or 30% of their gross inflows from outside the top 15 cities were permitted to charge another 0.3% of their AUM as expenses, over and above the 2.5%/2.25% cap set by SEBI. This condition has now been made more stringent, with SEBI requiring these flows to come from outside the top 30 (rather than 15) cities.
The changes in SEBI rules went into effect in April 2018. This caused a lot of fund houses to rework their expense ratio math. Some fund houses may have hiked their TER to compensate for the loss of the two sources of additional charges described above. This is concerning to you as an investor but you do not have to immediately exit. The NAV of a mutual fund is declared net of this expense ratio and ultimately any inordinate increase in this ratio shows up in the returns of the funds for investors. If these start to dip significantly below the fund’s benchmark and category average, you can consider exiting the fund.