How expensive is your fund?

From April 1 this year, SEBI had asked all mutual funds to revise their total expense ratios (TERs) in line with a new and tighter slab structure. While SEBI's intent was to make mutual funds less expensive, some schemes have found ingenious ways to either retain high TERs or even hike them after this rejig.

So, based on the TER mailers that your schemes have been sending you, how do you know if your scheme is fleecing you? It's difficult to gauge this in isolation because you have no idea of what its peers are charging or what is reasonable for the category. That's why this cover story is dedicated to taking a deep dive into mutual fund TERs so that you have benchmarks for each category against which you can measure your scheme. All the TERs mentioned pertain to May 31, 2019, two months after SEBI's new rules took effect.

Large-cap funds
Given the struggle that large-cap equity funds have had in keeping up with the indices recently, you would have expected these funds to display some humility and slash their expense ratios to remain in the game. But this simply hasn't happened, with actively managed large-cap funds still charging 2.23 per cent on an average after SEBI's cuts. But with established performers available at lower TERs, investors in this category need to think twice before investing in any fund that charges over 2 per cent. The TER differential between the regular and direct plans of large-cap funds stood at about 1.20 percentage points.

While active large-cap schemes aren't particularly cheap after the SEBI rejig, passive funds in the category offer mouth-watering deals. The average TER for passive funds in the large-cap category (ETFs and open-end funds included) was 0.36 per cent, with the median at just 0.17 per cent.

Click here to view all equity funds in the large-cap category. These may be sorted according to increasing or decreasing expense ratios.

Multi-cap funds
Multi-cap funds make for a good core portfolio option for investors because their tactical allocations in mid- and small-cap stocks help deliver better returns to investors. Multi-cap funds remain attractive after the SEBI changes because despite their superior return potential, they charge TERs very similar to those of large-cap funds.

The average TER for multi-cap funds stood at 2.30 per cent in May 2019, while the median was at 2.39 per cent. Thankfully though, long-term performers in the category are reasonably priced and there's no compelling reason for you to cough up over 2 per cent while choosing any multi-cap fund.

The category has recently seen the introduction of its first ETF, ICICI Prudential BSE 500 ETF, which charges a mere 0.30 per cent.

Overall, given that multi-cap equity funds promise better returns with comparable expense ratios, it now makes eminent sense for you to choose multi-cap funds over large-cap ones for your equity needs.

Tax-saving funds
Equity-linked savings schemes (ELSS), or tax-saving funds, are one equity category where investors are liable to be fleeced, with the average TER at 2.29 per cent. However, it is fairly easy for investors to steer clear of the ultra-expensive ELSS because good long-term performers are not that pricey. Direct plans are available at an average of 1.20 percentage points below regular plans.

Mid- and small-cap funds
Investors generally love mid- and small-cap equity funds for their outsized returns in bull markets. The category also has little competition from passive products. This makes these two the priciest categories of equity schemes.

While mid-cap funds charge 2.28 per cent on an average, small-cap funds go one step further to levy 2.37 per cent. As giant fund sizes pose an obstacle to performance in the mid- and small-cap categories, it is difficult to find seasoned performers that charge less than 2 per cent. However, TERs should not be your primary consideration while choosing small- or mid-cap funds. Your fund choice can make the difference between blockbuster returns and large losses in this volatile space. Therefore, the ability to navigate multiple market cycles and contain losses in big bear markets like 2008 are key attributes to look for.

Hybrid funds
Unfortunately, most hybrid funds are as expensive as equity funds despite their lower return potential. You may be surprised to know that the average TER for equity-savings funds, which park over two-thirds of their portfolio in debt and debt-like instruments, charge an average of 2.03 per cent. Or that conservative hybrid funds, with a 70-80 per cent debt allocation, levy equity-like TERs at 1.94 per cent. Aggressive hybrid funds, with average TER at 2.21 per cent, almost match equity funds on costs.

While these high fees do take a generous bite out of your returns on hybrid funds, hybrid funds serve a useful purpose owing to their tax efficiencies and automatic rebalancing feature.

You may check the expense ratios under each sub-category of hybrid funds by scrolling down on the home page of VRO, selecting the one you are interested in and then sorting them according to their expense ratios.

Debt Funds
TERs are more important in choosing debt funds than they are in equity because debt as an asset class offers limited opportunity for outsized returns.

Analysing the latest TERs of debt funds tells us three things. One, the riskier the category of debt fund, the higher its TER. To illustrate, liquid funds charge an average TER of just 0.27 per cent (regular plans), while medium- to long-duration funds, which take on far higher interest-rate risks, charge a steep 1.55 per cent. Ultra-short-duration, low-duration and short-duration funds, which average 0.74 per cent, 0.78 per cent and 1.07 per cent, respectively, are far cheaper than gilt funds (1.17 per cent) or medium-duration funds (1.41 per cent). Credit-risk funds, levying 1.58 per cent on an average, are the most pricey category of debt funds, while corporate-bond funds (0.85 per cent) and PSU and banking funds (0.63 per cent), which invest in top-rated bonds, are far cheaper.

Two, even within each debt category, funds that take on higher credit risks usually charge higher TERs. Debt funds that have high expense ratios are probably forced to chase higher-yielding bonds so that they can compensate their investors for their stiff fees.

Three, there's a very wide divergence in TERs within each debt category, which requires investors to pay close attention while picking debt funds.

The above findings buttress our long-standing argument that it simply isn't sensible for debt-fund investors to chase riskier categories of debt funds such as credit-risk funds, medium/long-duration funds, gilt funds or dynamic bond funds.

In the liquid-fund category, a majority of funds charge 0.25 percent or below. Among short-duration funds, TERs of 1.1 per cent or lower are the norm. You can also consider PSU & banking funds as substitutes for short-duration funds, provided their average maturity is below three years. Being aware of these benchmarks can help you buy debt funds that offer the best combination of performance and economy.