Can Mutual Funds Change Expense Ratio in the Share Market?

Investing in mutual funds involves paying various fees, one of the most important being the expense ratio. The expense ratio reflects the annual fee charged by a mutual fund to cover the costs associated with managing the fund, including administrative fees, marketing expenses, and management fees. While it might seem like a minor cost, the expense ratio can significantly impact the overall returns of your investment over time.

The question that often arises among investors is: Can mutual funds change their expense ratio after you have invested? The answer is yes, mutual funds can change their expense ratio, but this change is governed by specific regulatory guidelines and is subject to market conditions.

In this blog, we will explore the concept of the expense ratio, how it works in the Indian mutual fund industry, its impact on returns, and under what conditions it can change. We will also dive into historical trends and offer insights into how investors can manage and monitor expense ratios effectively.

Understanding Expense Ratio in Mutual Funds

The expense ratio is expressed as a percentage of the fund’s average assets under management (AUM). For instance, if a mutual fund has an expense ratio of 1.5% and an AUM of ₹1,000 crore, it means ₹15 crore will be deducted annually from the fund’s assets to cover its expenses.

Components of the Expense Ratio:

Management Fees: This covers the salaries and compensation paid to fund managers who are responsible for making investment decisions.
Administrative Costs: These are the operational costs of running the fund, including legal fees, accounting, and record-keeping expenses.
Marketing and Distribution Fees: Also known as 12b-1 fees, these cover the costs of marketing and distributing the fund, including paying commissions to brokers.
Other Expenses: Miscellaneous fees such as audit fees, custodial fees, and regulatory filing costs.

The total expense ratio (TER) is the sum of all these components and represents the overall cost to the investor. TER can differ based on the fund’s type (equity, debt, or hybrid) and size.

How Does the Expense Ratio Affect Mutual Fund Returns?

The expense ratio directly impacts the returns you receive from your mutual fund investments. It is deducted from the fund’s assets, reducing the returns passed on to investors.

Impact of Expense Ratio on Returns:

Fund AUM (₹)	Return before Expense Ratio	Expense Ratio (%)	Return after Expense Ratio
1,00,000	12%	1.5%	10.5%
5,00,000	12%	1.5%	10.5%
10,00,000	12%	1.5%	10.5%

For example, if your mutual fund generates a 12% return and has an expense ratio of 1.5%, your actual return after expenses will be 10.5%. This reduction might not seem significant in the short term, but over a long period, the impact of the expense ratio compounds and can result in a noticeable difference in returns.

Long-Term Impact of Expense Ratios:

Let’s consider an example where two funds generate the same returns before expenses, but one has a lower expense ratio.

Fund A (Expense Ratio 1%)	Fund B (Expense Ratio 2%)
₹10 lakh invested	₹10 lakh invested
Return: 12% p.a.	Return: 12% p.a.
Return after 1 year	Return after 1 year
₹1.1 lakh expense	₹2.2 lakh expense

Over 10-20 years, this difference can add up to a significant sum, underscoring the importance of tracking and comparing expense ratios when selecting funds.

Can Mutual Funds Change the Expense Ratio?

Yes, mutual funds in India have the flexibility to change the expense ratio. However, such changes are subject to the guidelines set by the Securities and Exchange Board of India (SEBI). The expense ratio can change due to several factors:

Factors that Influence Expense Ratio Changes:

Fund Size (AUM): A mutual fund’s AUM plays a crucial role in determining the expense ratio. As the AUM increases, the overall costs are spread over a larger base, potentially lowering the expense ratio. Conversely, if the AUM decreases, the expense ratio may rise to cover the fixed costs.
Regulatory Changes: SEBI can introduce new regulations that limit the maximum allowable expense ratio for certain categories of mutual funds. For example, in 2018, SEBI revised the expense ratio structure for mutual funds, capping the maximum expense ratio based on fund size.
Market Conditions: If the market experiences volatility and redemption pressures increase, the expense ratio may be adjusted to maintain fund profitability.
Competition Among Funds: To attract more investors, mutual funds may lower their expense ratios in response to competition from other fund houses offering similar schemes.

SEBI Guidelines on Expense Ratios

SEBI regulates the maximum permissible TER for mutual funds in India. As of the most recent guidelines, SEBI mandates that expense ratios must be tiered based on the fund’s AUM:

AUM (₹ Crore)	Maximum TER for Equity Funds (%)	Maximum TER for Debt Funds (%)
0-500	2.25%	2.00%
500-750	2.00%	1.75%
750-2,000	1.75%	1.50%
2,000-5,000	1.50%	1.25%
>5,000	1.05%	0.80%

SEBI’s 2018 Expense Ratio Revision:

In 2018, SEBI introduced a major change in the expense ratio structure. Under the new rules, SEBI capped the TER based on the AUM of the fund. Larger funds with higher AUMs are required to have lower expense ratios, benefiting investors by reducing their overall costs.

For equity-oriented funds, the TER was capped at 2.25% for AUMs up to ₹500 crore, while for debt-oriented funds, the maximum TER is capped at 2%. This regulatory intervention ensures that investors are not burdened by excessive costs.

Historical Data on Expense Ratio Trends in India

Over the past decade, the Indian mutual fund industry has witnessed significant growth, and as a result, expense ratios have seen fluctuations. Let’s take a look at some historical trends of expense ratios:

Expense Ratio Trends (2010-2023):

Year	Average TER (Equity)	Average TER (Debt)
2010	2.50%	2.00%
2015	2.25%	1.75%
2018	2.00%	1.50%
2020	1.75%	1.25%
2023	1.50%	1.10%

These trends show a gradual reduction in the expense ratios, especially after SEBI’s regulatory intervention in 2018. This reduction benefits investors by improving net returns and fostering a more competitive environment in the mutual fund industry.

How to Track and Compare Mutual Fund Expense Ratios

Tracking and comparing expense ratios is an essential step when selecting a mutual fund. Here are some tips on how to do so:

Check the Fund’s Factsheet: Mutual fund companies publish monthly factsheets that provide a breakdown of the expense ratio. It also lists the total returns and other key information.
Use Online Tools: Several online platforms and tools allow you to compare the expense ratios of different mutual funds, making it easy to assess which funds offer the best value for money.
Monitor Regularly: Keep an eye on the fund’s expense ratio over time. If the ratio increases significantly, consider whether the additional costs are justified by the fund’s performance.

Expense Ratio Comparison Tool Example:

Fund Name	Expense Ratio (%)
SBI Bluechip Fund	1.50%
ICICI Prudential Long Term Equity Fund	1.25%
HDFC Top 100 Fund	1.35%

By regularly checking and comparing expense ratios, you can make more informed decisions and potentially save on long-term investment costs.

Should You Worry About Expense Ratio Changes?

While changes in the expense ratio can affect your returns, they should not be the sole factor in your investment decision. A mutual fund with a slightly higher expense ratio may still provide better returns than one with a lower expense ratio, depending on its underlying strategy and performance.

Here are a few points to consider:

Performance vs. Expense Ratio: If a fund consistently delivers high returns that outperform the market, a slightly higher expense ratio may be justified.
Size of Investment: For smaller investments, the impact of the expense ratio is relatively minor. However, for larger portfolios, even a small change in the expense ratio can have a more significant impact on returns over time.
Active vs. Passive Funds: Actively managed funds tend to have higher expense ratios due to the costs of research and fund management. Passive funds like index funds typically have lower expense ratios because they simply track a market index.

Conclusion

Expense ratios play a crucial role in determining the net returns of your mutual fund investments. While mutual funds can change their expense ratios, these changes are regulated by SEBI and are often influenced by market conditions, fund size, and competition. Investors should remain vigilant, regularly reviewing expense ratios and comparing them across funds to ensure they are getting the best value for their investments.

Ultimately, the expense ratio is just one factor in selecting a mutual fund. Investors should also consider the fund’s performance, management team, investment strategy, and risk profile when making decisions. By understanding how expense ratios work and staying informed about changes, you can make smarter investment choices and maximize your returns over the long term.