Total expense ratio, and the math that decides whether your SIP is worth it.
A few basis points of TER, compounded over thirty years of an equity scheme, is the difference between a holiday and a house.
Most investors meet the total expense ratio in the same way they meet most financial concepts — late, and in passing, on the third page of a mutual fund document where the word "ratio" suggests something less significant than it is. The TER is the annual charge that a mutual fund deducts from the scheme's assets to pay for management, administration, distribution, audit, and the long list of small services that go into running a fund. It is expressed as a percentage of assets under management, and is the one number that a long-term investor should be able to recite.
The Securities and Exchange Board of India sets caps on what a scheme may charge. For equity schemes, the cap is tiered by the size of the scheme's assets, on the principle that scale ought to produce savings. A scheme with up to ₹500 crore under management may charge up to 2.25 per cent. A scheme with ₹500 to ₹750 crore may charge up to 2 per cent. Larger schemes pay less. The structure is sensible. The practice, less so.
The stickiness of the ratio
The TER is sticky. A scheme that hits a tier breakpoint does not always reduce its expense ratio in the same month; the AMC has flexibility within the cap, and uses it. A scheme that has grown by ten times since its launch may still charge an expense ratio closer to its first-tier cap than to its current size. The investor, who does not read the addendums, does not notice.
Two basis points of expense ratio, compounded for thirty years on an equity SIP of ten thousand rupees a month, is the difference between a holiday and a house.
The 2013 introduction of "direct plans" — schemes available without a distributor commission, at a lower TER — was the most consequential thing SEBI has done for the retail investor in a decade. A direct plan and a regular plan in the same scheme will hold the same securities, in the same proportions, but will charge different expense ratios — and over a working lifetime, the difference is enormous. The math does not change. The investor's exposure to the math does.
The slow correction
There is a small irony in the fact that direct plans were made possible by the same regulator that, twenty years earlier, had allowed AMCs to embed distributor commissions inside the expense ratio in the first place. The country's financial regulation, like its weather, is mostly a series of slow corrections to the previous ten years.