Does a lower TER assure higher returns from mutual funds?

The reduction in expense ratio of mutual funds is expected to help investors to save around Rs 1,300-1,500 crore every year, according to Sebi estimates. Sebi slashed the total expense ratio (TER) charged by mutual funds two weeks ago.

The TER for open-ended equity and debt mutual fund schemes was reduced by 25 bps. TER for open-ended equity scheme was capped at 2.25 per cent and that for debt funds was capped at 2 per cent. In case of close-ended and interval schemes, TER for equity-oriented schemes shall be a maximum of 1.25 per cent and for other than equity oriented schemes shall be a maximum of 1.00 per cent.

Sure, savings on lower TER would help you to make extra returns on your mutual fund investments. But does that mean you should place extra emphasis on mutual fund schemes with lower TER?


To get a concrete answer, we did a small study. We looked at the current total expense ratio charged by equity schemes and their one-year performance. We considered equity schemes including largecap, midcap, largecap and midcap, multicap, smallcap and ELSS. Next, we tried to find out if there a relationship between the total expense ratio and the returns.

To establish a relationship, we sorted the one-year returns of the schemes from highest to lowest. Next, we sorted their expense ratio in ascending order. We did this exercise for all categories separately.

The study did not show any material relationship between TER and returns. All schemes with lower TER did not figure among the top performers. For instance, Axis Bluechip Fund, a largecap scheme, is the category topper in the last one-year period. But its expense ratio was 2.53 per cent, which is higher than the average TER of 2.48 per cent for the category. The lowest expense ratio charged in the category is 1.38 per cent.

Similarly, in large and midcap category, the top three schemes in one-year period -- Sundaram Large and Mid Cap Fund, Invesco India Growth Opportunities Fund, and Edelweiss Large & Mid Cap Fund -- were charging higher than the average category expense ratio of 2.38 per cent. 57 per cent schemes in the category with low TER (below average expense ratio) could not even beat the average returns in the category.

We found similar trends in the severely beaten midcap category. Out of the 22 schemes, only four schemes generated positive returns in the last one-year period. And, all the four schemes charged more than their category average expense ratio.

Our observation was the same in other categories, including smallcap, multicap and ELSS funds. We could not trace any connection between the expenses and returns.

Mutual fund advisors also believe that while reduction in TER will benefit investors, it does not impact the performance of a mutual fund. “A scheme’s performance will depend on fund manager’s ability and market performance. Investors should definitely give more weightage to the fund’s performance than its expense ratio. But, in a case if two or more funds are equally good performers, an investor may choose the one with lower TER,” says Umesh Rathi, CEO Wealth, Arihant Capital.

For those who may argue over TER and returns of direct plans vs regular plans, it is always said that direct plans are meant for investors who understand the fundamentals and industry and can do the research, selection and review on their own. It is not wise to choose funds or options only on the basis of TER, Rathi adds.