Mutual Fund Mastery puzzles, solved step by step

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  1. 036A fund house manages Rs 2 lakh crore. Roughly how much fee income is one basis point worth to it each year?Estimation and market sizingWarm upIndian AMCsGlobal asset managers

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    Answer inside ten seconds.

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    About Rs 20 crore a year. A basis point is 0.01%, one rupee in every ten thousand. Rs 2 lakh crore is Rs 2,00,000 crore, and dividing by 10,000 gives Rs 20 crore. A handy anchor: one basis point on Rs 1 lakh crore is Rs 10 crore. To an investor holding Rs 1 lakh the same basis point is Rs 10 a year, which is why a fund house fights over fees its investors barely notice.

    How do you get the zeros right under pressure?

    A basis point is a hundredth of a per cent, so it is one rupee in every ten thousand, the way a paisa is one part in a hundred of a rupee. Convert the AUM into crore first, then move the decimal four places to the left; one basis point on Rs 1 lakh crore is Rs 10 crore, and every other size scales from that anchor. Rs 2 lakh crore is Rs 2,00,000 crore, so one basis point is Rs 20 crore.

    The relationship
    fee=AUM×bp10,000=Rs 2,00,000 crore×110,000=Rs 20 crore\text{fee} = \text{AUM} \times \frac{\text{bp}}{10{,}000} = \text{Rs }2{,}00{,}000\text{ crore} \times \frac{1}{10{,}000} = \text{Rs }20\text{ crore}
    AUMassets under management, Rs 2,00,000 crore
    bpthe fee in basis points, here 1
    What it says in wordsOne basis point of fee is the AUM divided by ten thousand, every year the money stays.
    One basis point is one rupee in every ten thousand, every yearAUMRs 2,00,000 crorex 1 basis point = 0.01% = 1 / 10,000move the decimal four placesFee income from that basis pointRs 20 crore a yearOne basis point a year, Rs croreRs 10,000 crore schemeRs 1 croreRs 1 lakh crore fund houseRs 10 croreRs 2 lakh crore fund houseRs 20 croreThe same basis point to one investor holding Rs 1 lakh:Rs 10 a year
    One basis point is worth Rs 1 crore a year on a Rs 10,000 crore scheme, Rs 10 crore on Rs 1 lakh crore and Rs 20 crore on Rs 2 lakh crore, but only Rs 10 a year to an investor holding Rs 1 lakh.

    Why does a fund house fight over a few basis points?

    Scale it up. A 10 basis point cut on Rs 2 lakh crore is Rs 200 crore a year of revenue gone, every year, with no saving in cost. At fund-house scale a basis point is real money, and a fee change is a large change in revenue for a business whose costs barely move with it. If the house earns, say, an average 0.50% across its book, its revenue is Rs 1,000 crore, and a 10 basis point cut takes away 20% of it. Those figures are illustrations; the shape of the arithmetic is the point.

    Why is the same basis point invisible to the investor?

    Because it is spread thin. An investor with Rs 1 lakh pays Rs 10 a year per basis point, the price of a cup of tea. The benefit of a fee change is concentrated in one balance sheet and its cost is spread across lakhs of folios, so the fund house argues hard and each investor shrugs. That is also why fee caps exist: in India the regulator caps the total expense ratioThe yearly cost of running a scheme, charged to the fund as a percentage of its assets and taken out of the NAV. in slabs that fall as a scheme grows. Confirm the current slabs before quoting them; they have been revised before.

    Where candidates lose it

    The trap is the zeros. Candidates mix up lakh crore and crore, or treat a basis point as 0.1%, and answer Rs 200 crore or Rs 2 crore with full confidence. Say the conversion out loud: two lakh crore is two hundred thousand crore, divided by ten thousand.

    The second loss is stopping at Rs 20 crore. The interviewer usually wants the next sentence: that a basis point is large for the house and tiny for the investor, which is why fee changes are fought over.

    What the interviewer asks next

    • A fund house cuts its fee by 5 basis points and gains 8% more AUM. Is its revenue up or down?
    • What is one basis point worth on an industry of, say, Rs 50 lakh crore?
    • Over 20 years, what does 50 basis points of fee cost an investor with Rs 10 lakh, roughly?