What are the various expenses charged by a fund? Is there any upper limit to these expenses?
There are three broad categories of expenses charged by a fund. Mutual funds are regulated by SEBI, and therefore, the maximum limits mentioned below for each of the expenses are also determined by SEBI.
A load is an expense charged at the time of buying and/or selling the units of a mutual fund. For example, most of the equity funds charge an entry load of 2.25 per cent these days which is deducted right at the time of making the investment. This is a charge from which the AMCs meet their selling and distribution expenses on an ongoing basis. The maximum limit for the load is 7 per cent.
These are expenses of running a fund. These involve a broad array of expenses like fund management fee, registrar fees, and selling and promotion expenses. All these fall under a single basket called 'expense ratio or annual recurring expenses' that is disclosed every March and September. Funds' NAVs are reported net of such expenses. As per the current SEBI guidelines, the maximum recurring expenses that an equity fund can charge is 2.5 per cent of the average daily net assets, and this percentage reduces as the asset size increases. The largest component of the expense ratio is management and advisory fees, which is subject to a maximum limit of 1.25 per cent out of the 2.5 per cent.
Since this is charged regularly (every year), a high expense ratio over the long-term may eat into your returns substantially as a result of compounding. For example, Rs 1 lakh over 10 years at the rate of 15 per cent will grow to Rs 4.05 lakh. But if we consider an expense ratio of 1.5 per cent, your actual total returns will be Rs 3.55 lakh, nearly 14 per cent less than what would have been achieved without any expense charge.
Initial Issue Expenses
Also known as new fund offer expenses, this is an expense which fund houses charge at the time of the launch of a fund and amortise it over a period not exceeding five years. This is subject to a maximum of 6 per cent of the amount raised during the new fund offer period. However, as per a recent SEBI guideline, open-end equity funds can no longer charge and amortise this expense. Rather, they will have to meet the issue expenses from the load itself.