All good things in the life comes at a cost and for mutual funds it is- Total Expense Ratio (TER).

Investment landscape globally has changed since the financial meltdown of 2008. Fixed asset classes, which have been one of the favorite investment tools for generations, failing to propagate desired returns and therefore, investors moving towards riskier bets. Over the past decade mutual funds have almost replaced all other asset classes by providing high returns with reasonably safe approach.

Total Expanses Ratio or TER of mutual fund is the total cost related to managing a fund. According to Investopedia, TER is a measure of the total costs associated with managing and operating an investment fund, such as a mutual fund. These costs consist primarily of management fees and additional expenses, such as trading fees, legal fees, auditor fees and other operational expenses.

To arrive at TER, total cost of the fund is divided by fund’s total asset. So, bigger the fund lesser is the TER.

How an investor is affected by TER?

Suppose an investor has invested Rs 1 lakh in a fund and TER is 2%-which means he has to pay Rs 2,000. This means if actual return from this investment is 12%, then it becomes 10 % diminishing by 2%. Now, note that TER is charged irrespective of the fact whether the fund has made a profit or a loss.

SEBI directive and reduction of TER

In 2018, Securities and Exchange Board of India (SEBI) decided to reduce TER across various types of mutual fund schemes to bring more transparency. As per SEBI decision, from now on TER for close ended-equity oriented schemes will be capped at a maximum of 1.25%. Previously, AMCs could charge as per the AUM slabs, where the base TER was charged at a maximum of 2.50%. Further, for non-equity oriented schemes TER will be capped at a maximum of 1%, according to a statement released by SEBI in September 2018.

It might be too early to predict but most asset management companies claimed that the commission rates will drop by 30 basis points on an average. This will make mutual fund business in India look unattractive. Due to market volatility, it has become difficult for distributor to sell mutual fund products. The TER cut will further act as a deterrent.

Moreover in 2017, the capital regulator had asked the fund houses to re-classify their cities for additional TER, which came into effect from financial year 2018. According to the directive Top 15 (T15) and Beyond top 15 (B15) has been changed to T30 and B30. (T30 refers to top 30 geographical locations in India and B30 indicates 30 cities beyond T30).

SEBI had also said that additional TER of up to 30 basis points would be allowed for inflows from beyond top 30 (B-30) cities instead of B-15 cities. Because of that the additional incentive would no longer be payable to distributors in top cities ranged between 16 and 30.

Asset management companies, mostly the bigger asset management companies whose costs are under control will continue to remain comfortable. but the survival terms will become difficult for the smaller companies especially the ones who have planned to expand their business aggressively.

In the end, investors are the biggest winner of the reduction of TER but at the same time, twin blow is expected to cause a severe dent to the profitability of AMCs and distributors.