Expense Ratio and Exit Load in Mutual Funds in India

A wise man once said, ''There is no free lunch on Wall Street.'' 

This holds when you are looking to invest in a mutual fund. Like any other business that charges you for their services, mutual funds charge a fee for managing your money. This includes:

• The fund management fee
• Agent commissions
• Registrar fees
• Selling and promoting expenses

All this falls into a single basket called the total expense ratio, which is disclosed daily and expressed as an annualised percentage of the fund's net assets. The expense ratio tells you how much you must pay to a fund as a percentage of your total investment every year to manage your money.

So, if you want to know how much the fund is deducting, the expense ratio can be found under the 'Disclosures' tab on the website of the given asset management company (AMC).

Since the expense ratio is charged regularly, a high expense ratio over a long period may significantly eat into your returns due to the power of compounding. 

For example, ₹1 lakh over ten years at 15% will grow to ₹4.05 lakh. But if you consider an expense ratio of 1.5%, your actual total returns would be ₹3.55 lakh, nearly 14% less than it would have been without any expense charge.

The most significant component of the expense ratio is management and advisory fees. From the management fee, an AMC generates profits. Then, there are marketing and distribution expenses. All those involved in fund operations, like custodians and auditors, also get a share of the pie. 

Here, the question you need to ask is, how much of an expense ratio can a fund house charge? Is it based on their discretion? Well, not really. Our market regulator, SEBI, has set a cap on the expense ratio that a fund house can charge from investors. Below is the table of the same taken from the AMFI’s website. 

Assets Under Management (AUM)	Maximum TER as a percentage of daily net assets
	TER for Equity funds	TER for Debt funds
On the first ₹500 crores	2.25%	2.00%
On the next ₹250 crores	2.00%	1.75%
On the next ₹1,250 crores	1.75%	1.50%
On the next ₹3,000 crores	1.60%	1.35%
On the next ₹5,000 crores	1.50%	1.25%
On the next ₹40,000 crores	Total expense ratio reduction of 0.05% for every increase of ₹5,000 crores of daily net assets or part thereof.	Total expense ratio reduction of 0.05% for every increase of ₹5,000 crores of daily net assets or part thereof.
Above ₹50,000 crores	1.05%	0.80%

The expense ratio especially matters in the case of debt funds. They are usually expected to give a return of around 7-9 %. Thus, in a low-yield universe, every penny counts. As expenses are deducted before calculating the NAV, it will likely be a significant differentiating factor among bond funds where returns vary marginally. 

In another case of actively managed equity funds, expenses are more complicated. The wide divergence of returns between 'good' and 'bad' funds makes the expense ratio secondary. But here, too, if you find two similar funds, the expense ratio can be a good differentiator. Perhaps more important is that expenses are charged at all times. Whether a fund generates positive or negative returns, expenses are always there.

How Can an Investor Save on Expense Ratio?

When you are looking to invest in a mutual fund, you'll notice two versions of the same mutual fund. One would have 'regular' mentioned in the name, while the other would have 'direct' written there. It is important to note that regular plans have a higher expense ratio than direct plans because they include distributor commissions. Even though it may not look substantial in percentage terms, the impact on the overall corpus becomes meaningful over a period of time, as you can see in the graph below. Therefore, if you can manage your investments, you may significantly lower your expense ratio and receive higher returns over time by sticking to direct plans. This is because, in direct plans, the AMC saves on the commission paid to the mutual fund agent in regular plans. 

If you can manage your investments, avoiding regular plans may significantly lower your expense ratio and receive higher returns over time. Though the difference in expense ratio per cent between a regular plan and a direct plan is not substantial, the impact on your overall corpus becomes meaningful over time. 

Let’s understand this with an example: Assuming the expense ratio of a direct plan is 1%. The regular plan is 1.75%, the value of ₹ 5 lakh invested at 12% per annum at the end of 20 years under different plans will be as follows:

Direct Plan:  ₹39.5 lakh

Regular Plan:  ₹34 lakh

As stated above, over the long term, expense ratio can impact your investment returns. Thus, carefully choosing a direct plan over a regular plan can help you save on your investment returns over the longer term. In this case, the difference was around ₹5.5 lakh. This difference can further increase in any of the following cases:

• If the difference between the expense ratio of a direct and regular plan is even higher
• The time horizon is longer than 20 years
• The investment amount is more than ₹5 lakh

Below is the graphical representation of the same.

To summarise, check the expense ratio before investing in a mutual fund. But remember that a lower expense ratio does not necessarily improve the fund. A fund that delivers good returns with minimal expenses is the way to go.

SEBI’s Recent Consultation Paper on Expense Ratio 

SEBI released a consultation paper on fund expenses to promote greater transparency and provide investors benefits of economies of scale. The document is wordy, 40 pages long, and covers every aspect of investors' expenses to AMCs for investing in their mutual funds. The document shows that the regulator is starting a comprehensive overhaul of fund expenses.

As per SEBI - the TER limit should include all expenses and charges. Currently, there are a few types of expenses that funds are allowed to charge over and above the total expense ratio limit imposed on them. These are:

• Brokerage/and commissions paid for transactions in the securities held
• Extra brokerage for the so-called B-30 cities
• An additional expense for exit loads
• GST on investment and advisory fees

The paper states that "The Total Expense Ratio, as the term suggests, should, in the interest of transparency, be inclusive of the total expenses charged to investors at any time. However, certain additional expenses can be charged over and above the TER; thus, there is ambiguity and lack of transparency in how mutual funds charge unitholders. Thus, it is desirable that TER reflects the maximum expense ratio an investor may pay. Hence, it should include all the expenses that are permitted to be charged from an investor, and any amount over and above the prescribed TER limits should not be charged from an investor. 

Things To Remember About Expense Ratio

Let’s end the discussion on expense ratio with the following key takeaways:

• The expense ratio refers to the cost you are paying to the AMC to manage the fund.
• A lower expense ratio is usually favourable, but you should align your investment objectives with the fund’s objective. 
• A direct plan's expense ratio is less than a regular plan's.
• The expense ratio is deducted directly from the daily investment amount, and you don’t need to pay it individually to an AMC.

Before venturing into any fund, the expense ratio is something you want to check. Remember that a lower expense ratio does not necessarily mean it is a better-managed fund. A good fund delivers a reasonable return with minimal expenses. With that, let’s move our discussion to exit loads now. 

Exit Load

Exit load is the charge levied when an investor redeems or sells their mutual fund units within a defined period. This is to discourage investors from selling their mutual funds before holding them for a suitable amount of time. Exit loads vary from one fund to another, and not all mutual funds impose an exit load. Hence, investors should consider a fund's exit load and expense ratio before investing in it. Also, note that the exit load is not part of the expense ratio.

The time period for which it applies varies with the type of fund. An important thing to note is that the time period is calculated from the date of investment, whether as a lump sum or a Systematic Investment Plan (SIP). Also, the exit load applicable at the time of investment (and not redemption) is considered. Even if a fund changes its exit load criteria,

it will apply only to investments made henceforth and not what was made before.

Calculating Exit Load in Lump Sum Investing

Suppose you invest ₹1,00,000 as a lump sum in a fund on November 1, 2022. At the time of investment, the exit load was 1 % for 365 days. The NAV of the fund on November 1, 2022, was ₹ 20, so you were allotted 5,000 units (1,00,000 divided by 20). 

On June 25, 2023, you decided to withdraw ₹ 50,000. Let's assume the NAV is ₹ 25 on June 25, 2023. So you have redeemed 2,000 units (50,000 divided by 25). 

At the time of payout, an exit load will be charged since you have withdrawn within 365 days of the investment date. 

Exit load = 1% of (2,000 units x ₹ 25 per unit) = ₹ 500 

Therefore, the amount received upon redemption = Value of units redeemed - Exit load 

= (2000 units x ₹ 25 per unit) - ₹ 500 i.e., ₹ 50,000 - ₹ 500 = ₹ 49,500 

Now, if you had made the redemption after November 1, 2023, i.e., upon completion of 365 days from the date of your investment, then you would not be subject to any exit load.

Calculating Exit Load in SIPs

Now, let's understand the complexities of your investment via SIPs. Suppose you have set up a SIP of ₹10,000 for the 1st of every month, beginning on April 1, 2022 and ending on March 1, 2023. 

At the time of investment, the exit load was 1 % for 365 days. On June 25, 2023, you plan to withdraw ₹ 50,000. Let's take a look at what your investments would look like.

Now, it is clear from the table above that 297 units have been invested for more than 365 days and the remaining for lesser periods. Let's assume that the NAV as of June 25, 2023, is ₹100, and you need ₹50,000. 

So, the units to be redeemed are 500 (50,000 divided by 100). However, only 297 units are free from any exit loads. Hence, the exit load will be calculated as follows: 

Number of units to be redeemed = 500 units. 

The number of units on which exit load applies = 500 - 297 = 203 units

Exit load = 1 % of (203 units x 100 per unit) = ₹203

The amount received upon redemption = Value of units redeemed - Exit load
i.e., (500 units x 100 per unit) - ₹203
i.e., ₹50,000 - ₹203 = ₹49,797

As you can see, you received less than the amount you wanted to withdraw in both of the above cases. This is due to the exit load. Additionally, the exit load applied will be based on what was applicable at the time of investment. 

Continuing the above example, suppose the exit load was changed on July 15, 2022, to 1.25 % for 365 days. Now, the calculation of exit load would be slightly different. It would be as follows:

Number of units to be redeemed = 500 units
Number of units on which exit load applies = 500 - 297 = 203 units

Redeemable units acquired before July 15, 2022 = 396 units
Redeemable units acquired after July 15, 2022 = 500 - 396 = 104 units

Number of units on which 1.25% exit load will be applicable = 104 units
Number of units on which 1% exit load will be applicable = 203 - 104 = 99 units

Total exit load = 1% of (99 units x 100 per unit) + 1.25% of (104 units x 100 per unit)
i.e., 99 + 130 = ₹229

As you can see, the total exit load has increased from ₹203 in the previous case to ₹229 because of the change in exit load, w.e.f., July 15, 2022, and the change applies only to investments made afterwards and not to the ones made before the change. 

Where Can You Check the Expense Ratio and Exit Load on Angel One?

To check the basic information of a mutual fund:

1. Open the Angel One app and go to the Mutual Fund section of the Home page. 
2. Find the mutual fund you want to check the details of and click on it.
3. Once you reach the fund details page upon clicking on the fund name once more, scroll down to find the basic information related to the fund, including expense ratio and exit load.

Conclusion

This was all about the expense ratio and exit loads. These are among the few charges that you, as an investor must know before mutual fund investing. However, please note that there are other charges, too, and this is not an exhaustive list.