Total Expense Ratio (TER) is the measure of the total costs or expenses in running a scheme. This measure is used by investors to compare the costs of the scheme with its peers and also in relation to the returns available from that scheme. It is a key element in making an investment choice, as those funds which consistently show a high TER may not provide high returns, since high expenses tend to erode the returns generated.
Expenses Associated with Operating a Fund
TER is the measure of all the expenses associated with running a scheme. These can include:
Management fees, probably the single largest item in the TER of a fund. These fees cover items such as fund manager salaries and research fees.
Brokerages and taxes in transacting the securities of the scheme.
Fees paid to trustees, registrar and transfer agents, custodians, personnel of the trustee and Asset Management Company, etc.
Legal and accountancy fees;
Sales and marketing expenses.
Any other operational expenses like rent, electricity, communication, etc. in proportion to the assets of the scheme.
How is TER Calculated?
The calculation used for determining TER is the following:
Total expense ratio = (Total costs of the scheme during the period / Total Fund Assets)*100.
TER is typically expressed as an annualized percentage of the assets of the fund. Since open ended funds’ assets vary on a daily basis, the proportionate TER is accounted for in the scheme Net Asset Value (NAV) on every business day when the NAV of the scheme is published.
The calculation describes, in mathematical terms, the costs of running the scheme with respect to the total assets under management. However, this number should either stabilize or reduce over time as the fund becomes larger. The fixed costs such as administrative overheads are spread over a larger asset base thus reducing its percentage contribution to the cost structure. Moreover, Securities Exchange Board of India (SEBI) stipulates that fund management fees slide with increase in assets of the scheme. Larger the scheme size, lower the fund management fees as per slabs prescribed by SEBI.
What does TER indicate?
When evaluating a fund, you are advised to give preference to funds with lower and / or decreasing TER. Generally, the lower the TER, the higher the possible return; the TER is published by all funds in their factsheets and needs a close look to determine improvements or deterioration. It is pertinent to note that TER is incurred irrespective of whether a scheme has generated a positive return for its investors or not.
TER is also dependent on the fund management style. You will see that there is usually a difference in TER for active and passive funds. This is because passive funds generally replicate the identified index; as they do not require active management, they have less overheads; for example, they do not pay for stock selection research.
If you notice a continuous increase in TER, without improvement in the performance, consult your financial advisor.