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How Fund Companies Make Money

Do you ever wonder that what mutual funds get out of managing your money and how are they compensated for the same. Read ahead to know how fund companies get paid

I have been wondering what mutual funds get out of managing my money? If they get anything and I assume they would, is this based on performance and does this change from fund to fund?
Arvind C. Jain via e-mail

There are no free lunches in life and this applies to mutual funds also. Mutual funds charge a fee called investment and advisory fees for managing your money and this deducted from the NAV and accrues on a daily basis. The upper limit of this fee is capped by regulations and is independent of the performance of the fund. Thus in an equity scheme, the fund can charge upto 1.25 per cent for the first Rs 100 crore of assets. If the fund manages any sum above Rs 100 crore then it can charge upto 1 per cent for the excess amount. For debt schemes, the fee is lower by 0.25 per cent for each slab. So effectively for an equity fund, which is not more than Rs 100 crore in size, the maximum management fee that an asset management company can charge is 1.25 per cent and for a similar sized debt fund it is 1 per cent.

But if a fund is launched on a no-load basis and does not levy any initial issue expenses, then the asset management company can charge upto 1 per cent more, as management fee for each financial year. For this reason there are a few funds, which are charging slightly more than the limits we have mentioned.

While the upper limit is effectively capped depending on whether a fund is an equity fund or a debt fund, an AMC can charge a lower management fee if it wants to. Two categories of funds where this happens are index funds and the institutional plans of debt funds. In an index fund the AMC does not have to take an active call on which stocks to buy and sell. The fund just has to replicate an index, so research and other management inputs are minimal. Consequently the management fee charged here is much less. The category average management fee for index funds is thus 0.65 per cent as compared to 1.14 per cent for actively managed diversified equity funds. Similarly, institutional debt funds have been launched with the purpose of passing on the lower cost of mobilizing funds to their unit holders. One way of doing this is to charge a lower management fee. Thus the category average management fee for medium term institutional funds is 0.53 per cent as compared to 0.84 per cent in medium-term debt funds, which are purely retail in nature.

The management fee that you pay a fund company to take care of your money is a component of the expense fee. Expense fee (also called expense ratio) tells you what part of your returns is being consumed to administer and manage your money. If your fund has given you a return of 10 per cent and its expense ratio is 1.2 per cent then your fund had actually generated 11.2 per cent. So, this fee is more relevant to you than just the management fee. While the management fee just tells you what portion of your investment is being consumed by the AMC, the expense ratio tells you the total value of your investments, which are being consumed in running the fund, and this includes other costs such as advertising and marketing. The expense ratio of an equity fund cannot exceed 2.5 per cent of the assets under management, while for debt funds the limit is 2.25 per cent. To learn more about the expense ratio please click on this link Expense Ratio

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