Most investors pay little attention to annual expenses, which are ceremoniously tugged in a corner of offer documents. However, these costs are important since they are charged from the scheme's assets under management and impact the net asset value and returns to investors. While the Securities and Exchange Board of India has put a ceiling on annual expenses, it is important to note whether your asset management company is also making a conscious effort to bring down the costs of managing the fund. Annual expenses include investment management fee, marketing and selling expenses, cost of custodian, registrar and transfer agents.
Ideally, the annual expenses should come down as assets under management balloon. With the corpus of most Indian funds witnessing a quantum jump in the last two years, some of them have been magnanimous towards unitholders and reduced annual expenses as assets grow. On the other hand, there are some funds that act in a miserly manner, and have either maintained or even raised their fees despite a jump in assets.
When a mutual fund's assets boom, an asset management company has the option (though its not mandatory) to charge lower annual expenses and thus, pass the savings to investors. For example, a fund with a 2 per cent expense ratio and Rs 100 crore in assets receives Rs 2 crore a year to pay the fund manager and cover administrative costs. If now, the assets gallop to Rs 500 crore, the charges pegged at 2 per cent would translate to Rs 10 crore as annual expenses. While some funds could just take home that extra cash flow and buoy the earnings of the AMC, most funds are benevolent towards their unitholders and pare down annual fees.
Take for instance, Zurich India High Interest from Zurich India Mutual Fund. With Rs 69 crore in assets in 1999, the fund charged investors 1.88 per cent as annual expenses. However, with the fund receiving fresh inflows, the corpus of the fund zoomed to Rs 228 crore in 2000 and the fund's annual fee now stands at 1.44 per cent, 44 basis points or 23.4% lower than it was in 1999. In fact, expenses are vital in a bond fund, where lower annual costs could pep up the NAV by few basis points and help provide investors with higher returns. But there are some funds, which are reluctant to reduce fees, even after their assets gallop. Take for instance, Kothari Pioneer Income Builder. Despite an over 350 per cent jump in size between 1999 and 2000, the fund's annual expenses have jumped by 13 basis points to 1.65 per cent. Thus, the AMC is expected to have raked in approximately Rs 6 crore in 2000 as annual costs in Income Builder against a little over Rs 1 croe in 1999. Or for example, consider Alliance Equity from Alliance Mutual Fund. The fund's annual expenses have shot up from 1.99 to 2.21 per cent despite the jump in assets from Rs 66 to Rs 807 crore.
Sure, its time investors became vigilant about their fund's expenses and forced fund houses to take advantage, as economies of scale drive down operating ratios of funds.