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Varying Expenses of Liquid Expenses

The lure of liquid fund diminishes with rising expense ratios, which have a significant impact on the returns

It is a well-known fact that debt funds account for 75 per cent of the mutual fund industry's total assets under management. Of this, liquid funds account for a significant 37 per cent, making them much sought after. Liquid funds are those funds in which investors park their money for the short term, and yet not lose out on any liquidity. That these funds are tax efficient makes them sought after by several retail investors besides corporate and HNIs.

Given the narrow range of returns from these funds, their expenses matter immensely in tilting the scale towards one fund over the other. At present, the expected returns is in a narrow range of 7 to 10 per cent for a year. Which means, a higher expense ratio eats into the investor's returns as expenses are deducted from the fund's NAV. So, investors need to be cautious when selecting a fund in this category.

We checked the expense of the 59 liquid schemes and figured that there is a more than one per cent difference between the fund with the least expense ratio and those with the highest expense ratio among liquid funds. The minimum a fund charged was 0.08 per cent while the maximum was twice at 1.16 per cent as on March 31, 2014.

The expense ratio has an impact on the quantum of return; a lower rate eats less into the overall returns and vice versa. For instance, Birla Sun Life Cash, the second largest fund with an asset size of ₹20,127 crore in this category charged more than twice what the largest fund ICICI Prudential Liquid Plan with an asset base of ₹23,235.86 crore did on March 31, 2014 at 0.12 per cent expense ratio. While the fund posted 9.59 per cent returns, which would satisfy most investors, it managed to earn more to the tune of ₹26 crore, assuming what it would have earned if it had charged the lower expense.

Expenses play an important role

  • A fund being good or bad has little to do with its expense ratio
  • There is no correlation between a funds' expenses and its performance
  • In case of debt funds, even small differences in the expense ratio can make significant impact on their relative performance
  • When selecting a fund, ask yourself how materially can the expense ratio impact the returns of the fund?

Likewise, IDFC Cash Fund earned over ₹60 crore with an expense ratio of 0.87 per cent, which is 75 basis points higher than the largest fund despite managing only one third of its asset size. Even the argument that higher returns would compensate for the higher expenses charged does not hold true as the return generated by these funds was in a close range of 9.41 per cent to 9.59 per cent.

For investors it may not matter how much a fund charges by way of expenses as long as they earn good returns, but remember, the fund is earning from you, even if it is posting high returns. There is an opportunity loss to investors where the funds charge a high expense ratio. The lesson: do not focus on returns alone when selecting a liquid fund, do look at the expenses to invest in a fund that is low on expenses and high on returns.