How Mutual Fund Expense Ratios Work: The Daily Charge

An expense ratio is charged against the scheme's own assets every day, not billed to the holder. A scheme with net assets of Rs 4,200 crore and a ratio of 1.65 per cent gives up Rs 69.30 crore across a year, about Rs 0.1899 crore a day. The net asset value is struck after that day's accrual, so nothing appears on a statement.

Here is what sits underneath that. An expense ratioThe charge running against a scheme's assets, expressed as a percentage of assets a year. is quoted as a percentage of assets a year. The wording makes it sound like an annual bill. No bill is ever issued. The charge runs continuously, converted into a small amount every single day, set against the scheme's assets before the value of a unit is worked out, and then absorbed into that value. The reason the charge is invisible is not that anybody is hiding it, but that it was never a payment in the first place; it was a subtraction from the pool before the pool was divided.

One scheme runs through this guide from end to end. Girnar Asset Management Limited, an invented asset manager, operates the Girnar Large Cap Equity Fund, an open ended equity scheme with net assetsWhat the scheme holds less what it owes, which is the amount the ratio is charged on. of Rs 4,200 crore and 120.00 crore units outstanding. Divide the first by the second and the value of one unit is Rs 35.00 exactly. The scheme is held across 3,80,000 folios and carries an expense ratio of 1.65 per cent. Kalyani Bhagat manages the portfolio and Sohail Merchant heads operations.

Three things are settled elsewhere and are taken as given here. A unit value is computed each day. A load is charged once on a transaction. The charge examined here runs continuously. The scheme's assets belong to the people holding units, not to the asset manager, so a charge against those assets is a charge on those people even when no one is invoiced.

Who is actually paid out of a scheme's expense ratio?

The ratio is not one payment to one party. The ratio is a pool out of which a set of working roles is paid. The roles are the same whichever manager runs the scheme, so naming the roles is more useful than naming any organisation. Somebody manages the portfolio. The registrar and transfer agentThe party that maintains folio records and processes transactions. keeps the folio records and processes every purchase and redemption. The custodianThe party that holds the scheme's securities. holds the securities and settles the trades. The trustee companyThe party that holds the scheme in trust for the people who hold its units. holds the scheme in trust for the people who hold units in it. An auditor audits the accounts. And where a distributor brought the investment in and continues to service it, a distribution commission is paid out of the same pool.

Think of a housing society for a moment. Every flat pays a monthly maintenance amount, and out of that one amount the society pays a security agency, a lift contractor, a water tanker supplier, an accountant and an auditor. No flat owner gets six separate bills. One charge goes out and several parties are paid from it, and the residents can still ask what each of those parties is being paid for. A scheme's expense ratio behaves in the same way: one running charge, several roles paid out of it.

Which of these items may be charged to a scheme at all, and whether there is any limit on the total, is set by the Securities and Exchange Board of India (SEBI). Charge rules move, they are written down, and they are checkable in a few minutes at sebi.gov.in. A limit printed from memory does not become dated when the limit changes. The limit becomes wrong, and a reader has no way of knowing which of the two they are reading.

How does an annual percentage become annual rupees?

Multiply, and say the baseThe amount a ratio is measured against, without which the ratio states nothing. out loud in the same sentence. The Girnar Large Cap Equity Fund has net assets of Rs 4,200 crore, and 1.65 per cent of Rs 4,200 crore is Rs 69.30 crore for the year. Written in full rupees rather than crore, that is Rs 69,30,00,000/- coming out of the pool across twelve months.

A ratio without its base is not a number, so the base is named every single time it is used. The insistence sounds like pedantry until the two places it bites come into view. A person quoting 1.65 per cent without saying of what could mean of the assets, of the amount invested at the start, or of the gain. Assets, amount invested and gain are three different amounts, and they produce three different answers. A second reader compares 1.65 per cent on one scheme with 1.65 per cent on another and is comparing rates on bases that are not the same size. The comparison is fine for the rate and meaningless for the rupees. The base comes first, then the rate, then the rupees, in that order.

What does that come to in a single day?

The year divides into days. Rs 69.30 crore across 365 days is about Rs 0.18986 crore a day. In full rupees that is about Rs 18,98,630/- a day. The daily amount moves a little with the convention the scheme uses for counting days. The year is held at 365 days throughout, and that choice is stated rather than left silent.

The daily amount is charged against the scheme's assets rather than collected from its holders, so it is one number for the whole scheme and not a bill sent to anybody. Nothing is invoiced, nothing is debited from a bank account, and nothing is deducted from a folio. The scheme simply has slightly less in it at the end of the day than the day's trading alone would have left it with. The subtraction is the entire mechanism, and every figure that follows is arithmetic hanging off it.

What does one day's charge come to per unit?

Divide the day's amount by the units in issue. About Rs 0.18986 crore across 120.00 crore units is about Rs 0.0015822 a unit for that day. A sixth of one paisa, per unit, per day, is small enough that nobody would notice it and small enough that nobody could react to it even if they did.

The same charge is trivial in the hand and large in aggregate, and the gap between those two impressions is exactly why an expense ratio is so easy to ignore. A sixth of a paisa per unit sounds like a rounding error. Multiplied by 120.00 crore units it is Rs 18,98,630/- in a day, and multiplied again by 365 it is Rs 69.30 crore in a year. Nothing has changed except the frame it is looked at in, and the two frames produce completely different feelings about the same fact. Holding both impressions at once is what makes a running charge legible.

Does the same figure turn up when it is computed another way?

The same figure does turn up, and getting there by a route that shares no arithmetic with the first is worth more than it looks. The ratio comes first and the money second. An annual 1.65 per cent divided by 365 days is about 0.0045205 per cent a day. Applied to the value of one unit, Rs 35.00, that gives about Rs 0.0015822. The first route went through the whole scheme and divided by units at the end. The second route never touched the scheme's total at all. Both routes land on the same number.

Two independent routes reaching the same figure show the arithmetic to be right rather than merely plausible. The habit is worth carrying into every calculation. A single chain of divisions can be wrong in a way that looks perfectly reasonable, because a slip in one step simply carries forward and every later step is consistent with the error. A second route built out of different inputs cannot inherit that slip. When the two disagree, one of them is broken and the search for the fault can begin. When they agree, the checking can stop and the number can be used.

There is a third route sitting right there as well, and it is worth doing because it closes the loop back to the opening figures. The charge per unit for a whole year is 1.65 per cent of Rs 35.00, or Rs 0.5775 a unit. Multiplied by 120.00 crore units, that returns Rs 69.30 crore for the scheme for the year. The chain now runs in both directions and meets itself at both ends.

When inside the day is the charge actually applied?

Before the unit value is computed, and that ordering carries the whole mechanism. Inside one working day the scheme's holdings move with prices, up or down. The day's expenses are then set against the assets as an accrualAn amount recognised as owed by the scheme and set against its assets before the unit value is struck.. The net assets figure is what remains after that accrual. Only then is that figure divided by the units in issue to produce the value of one unit. That value is the number that gets published.

Because the accrual happens first, the published value is already net of the charge, and the consequence is that no holder is ever asked for anything. No cash leaves the folio. The number of units does not move. Nobody has to remember a due date or keep a balance available. The charge has been taken, in full, and the only trace of it is that the value per unit is a fraction lower than it would otherwise have been. The accrual convention a scheme must follow is SEBI's, and it sits at sebi.gov.in.

Why does the charge never appear on a statement?

Because there is no line it could appear on. A folioThe account recording one holder's units in one scheme. statement shows two things that matter here: the number of units held, and the value of each unit. The charge did not touch the first of those. The charge moved the second, by a fraction of a paisa a day, along with everything else that moved it, such as the prices of the securities the scheme holds. There is no row for a deduction because nothing was deducted from the holder.

A shopkeeper who raises the price of rice by two paise a kilo has charged every single customer and has issued a bill to nobody. No customer can point to a line on a receipt showing the increase, because the increase is not a line on the receipt; it is the receipt. A holder in the Girnar Large Cap Equity Fund is in precisely that position. The charge is not absent from the statement because somebody left it out. The charge was applied to the price rather than added to the total, and a price does not itemise itself.

Does a holder with more money pay more?

Yes in rupees and no in rate, and both halves of that answer matter. Take two folios in the same scheme. One holds Rs 25,000/-. The other holds Rs 25,00,000/-, a hundred times as much. The ratio applies to the assets sitting behind the units, and a hundred times the units sit behind a hundred times the assets. Both folios carry the identical expense ratio of 1.65 per cent. In rupees, the first folio carries about Rs 412.50/- for the year and the second carries Rs 41,250/-. In rate, they are indistinguishable.

The rupee figure reveals how much money somebody has and the rate reveals what the scheme costs, so a percentage charge is what makes two holders comparable. Asking two people what they paid last year reveals the size of their holdings. Asking what ratio they carried reveals something about the schemes. Proportionality is also why nobody in a scheme is subsidising anybody else. A large holding is not buying its administration at a discount, nor a small one at a penalty.

What base is this arithmetic actually standing on?

One figure, held constant, and that has to be said aloud. A ratio of this kind is properly struck on the average net assetsThe asset base averaged across the period a ratio covers, rather than a single day's figure. across the period it covers, not on a single day's assets. Net assets move every day, with prices and with money coming in and going out, so the honest base is an average of many daily figures. Only one asset figure for the Girnar Large Cap Equity Fund is available, Rs 4,200 crore, with no daily or monthly series behind it. The average is therefore not computable.

Declaring that assumption is the difference between an illustration and a claim. The declaration costs nothing. The silence costs everything. The arithmetic above holds the base at Rs 4,200 crore throughout, which makes every figure in this guide an illustration of the mechanism rather than a statement of what the scheme actually gave up. If the assets had averaged more across the year, the rupee amounts would be higher; if less, lower. The shape of the chain, and every division in it, is unaffected. A reader who knows which of those two things is in hand can use the arithmetic. A reader who does not has been handed a number wearing a costume.

What does the whole chain look like, run end to end?

Here is every step in one place, on the Girnar Large Cap Equity Fund, with the base held at Rs 4,200 crore and the year held at 365 days. Watch each division rather than reading the results.

The two routes agree. But a per unit figure at seven decimal places teaches nobody anything on its own, so it has to be brought down to the level of a person. A holding of Rs 1,00,000/- in this scheme carries 1.65 per cent of Rs 1,00,000/-, or Rs 1,650/- for the year, about Rs 4.52 a day. The average folio is a little larger: Rs 4,200 crore spread across 3,80,000 folios is about Rs 1,10,526/-, and 1.65 per cent of that is about Rs 1,824/- a year, or about Rs 5.00 a day.

Both are true: about Rs 5.00 a day for the average holder, and Rs 69.30 crore a year for the scheme. Hold the two impressions side by side and do not resolve them. Neither figure is the honest one and neither is the misleading one. Five rupees a day is what the charge feels like at the level of a person, and it is the reason nobody changes their behaviour over it. Rs 69.30 crore a year is what the same charge is at the level of the scheme, and it is the reason the six working roles can be staffed and paid. The charge is small and the charge is large, and a reader who can carry both sentences at once understands the mechanism better than one who has picked a side.

Girnar Asset Management Limited, the Girnar Large Cap Equity Fund, Kalyani Bhagat and Sohail Merchant are invented.
Educational material. Not advice on any investment, tax, budget or market position.