Investors have been receiving mails from mutual fund companies on a frequent basis these days regarding change in the expense ratio.Why? To understand this, read my article in Mid-day Gujarati here …

The English translation is as under:

“My mutual fund is changing the expenses daily these days. Isn’t there any regulation governing this? What has happened suddenly?” An investor asked his advisor during one of the interactions.

Investors have been receiving mails from mutual fund companies on a frequent basis these days regarding change in the expense ratio. It is not that the changes have started happening now. This was happening earlier, too. However, recently SEBI issued a circular to all the fund companies to send an email communication to every investor every time there is a change in the expense ratio.

In that case, if there is a change in the expense ratio every day, the investors are likely to get a mail daily.

Why do the fund houses change the expense ratio every day?

Many times, this is not done with a purpose. It just happens. In order to understand why such a thing just happens, we need to understand the way expense ratios are calculated.

SEBI has set guidelines for the purpose of expense ratios that can be charged to the scheme. These guidelines have set a maximum limit beyond which the expenses cannot be charged to the scheme. According to the same guidelines, the expense ratio limit keeps coming down as the size of the portfolio increases. This means that the ceiling for expense ratio would be lower for larger funds as compared to smaller funds. But this puts a twist in the story.

Since the expense ratios are calculated daily, any fluctuation in the size of the portfolio would mean that the average expense ratio might change. Let us understand this through an example of an equity fund:

Maximum expense ratio that can be charged *

For the first Rs. 100 cr of assets: 2.50%

For the next Rs. 300 cr of assets: 2.25%

For the next Rs. 300 cr of assets: 2.00%

For the assets thereafter: 1.75%

(* The actual expense ratio can be a bit higher since SEBI regulations allow certain other charges, e.g. GST on the asset management fees to be added to the expense ratio).

In such a case, for a scheme that manages Rs. 900 crores of assets, the maximum allowed expense ratio could be:

Rs. 100 cr X 2.50% + Rs. 300 cr X 2.25% + Rs. 300 cr X 2.00% + Rs. 200 cr X 1.75% = Rs. 18.75 cr

Rs. 18.75 cr is 2.08% of the assets. (Rs, 18.75 cr / Rs. 900 cr = 2.08%)

Let us assume that the portfolio value drops by Rs. 10 cr on a day. This could be due to a redemption or due to drop in prices of shares. In such a case, the expenses would change as under:

Rs. 100 cr X 2.50% + Rs. 300 cr X 2.25% + Rs. 300 cr X 2.00% + Rs. 190 cr X 1.75% = Rs. 18.58 cr

Rs. 18.58 cr is 2.09% of the assets. (Rs, 18.58 cr / Rs. 890 cr = 2.09%)

As you can see, a drop of Rs. 10 crores in an asset size of Rs. 900 crores leads to an increase of 0.01% in the expense ratio.

This is a routine change and should not concern you. However, if there is a much larger change, you should take notice and dig deeper to understand the reasons behind it.

The regulation aims to increase transparency in the practices of mutual fund companies and is a very good regulation. It is just that an investor should not panic due to the information overload and make mistakes.