Sunday, October 22, 2006

Expenses Exposed !!!!

Expenses Exposed!!

"Dazzled by performance, indifferent to cost," is a common accusation hurled at Mutual Fund investors. I would have succeeded in my endeavour if I elevate you to well above the average in the next 500 words or so.

Management Expense Ratio or MER.
The MER is the total expense of operating a Mutual Fund expressed as a percentage of the fund's Net Asset Value (NAV).

The major components of Expense Ratio are

The Investment Advisory Fee or The Management Fee: This is the money that goes to pay the salaries of the fund managers and other employees of the Mutual Funds. The management fees (which could range from 1% to 1.25% of the fund's corpus) are one of the highest expenses incurred by a Mutual Fund.

Administrative Costs: These are the costs associated with the daily activities of the fund. These include the costs of record keeping, mailings, maintaining a customer service line, etc. These are all necessary costs, though they vary in size from fund to fund. The thriftiest funds can keep these costs below 0.20% of fund assets, while the ones who use engraved paper, colorful graphics etc. might fail to keep administrative costs below 0.40% of fund assets.

Limits have been mandated by SEBI on operating expenses. On the

First Rs. 100 crores 2.25%
Next Rs. 300 crores 2.00%
Next Rs. 300 crores 1.75%
On the balance of assets 1.50%

Any excess over the specified limits has to be borne by the asset management company, the trustees or the sponsor.

One ongoing expense that is not included in the expense ratio is brokerage costs incurred by a fund as it buys and sells securities. These costs are listed separately in a fund's annual report. When mutual fund managers buy and sell a high number of stocks, with frequency, within a fund, it will have a high turnover rate, causing a higher capital gains tax and vice versa. Check the fund reports for the turnover rate. A rate of 80 or less is usually considered low.

For actively managed funds, the average expense ratio is rising as funds shift fees away from the up-front loads that they know are driving sales away, into the annual expense ratios where they are more easily hidden. This fee is charged and deducted from the fund regardless of its performance and for as long as you hold this Mutual Fund.

All these expenses that we have mentioned so far can be thought of as coming out of the portfolio's raw return, skimmed off the top, so to speak. For a full understanding of fund expenses, a careful perusal of the Offer Document and the Annual Report is absolutely essential. An informed investor knows where his money is going. He keeps tab on the toll he doles out on the highway to big money.

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