The total expense ratio (TER) of equity mutual fund (MF) schemes may rise following a steep drop in their assets under management (AUM) in the past two months. This could further dent investor returns, which have fallen significantly because of the market crash last month.

The AUM of equity schemes have declined 27 per cent to Rs 5.8 trillion at the end of March, from Rs 7.9 trillion two months ago. In the same period, the number of equity schemes that managed between Rs 10,000-50,000 crore has reduced to 14 from 21. Similarly, the number of schemes that fell in the range of Rs 5,000crore and Rs 10,000 crore has dropped to 23 from 35, the data from Value Research shows. This assumes significance as the TER for these schemes will have to be realigned.

“The TER is a function of the size of the fund. Size changes with inflows and the net asset value (NAV) growth. So when the AUM grows the cost comes down. Similarly, if the AUM comes down, the TER would change as per slab,” said Swarup Mohanty, chief executive officer, Mirae Asset MF.

The TER is an annual charge deducted from the NAV daily. It includes fund management charges, marketing and distribution costs, and registrar and transfer agent (R&T) expenses, among others. Expenses for direct plans are typically lower as there are no commissions paid to the distributor.

The TER is calculated on a slab-based formula, and had seen a downward revision last year across equity and non-equity categories following a regulatory diktat.

“It is likely that TER might go up a bit to the extent the regulations permit. Moreover, the decline in the AUM has put pressure on the margins of fund houses and may necessitate an increase in expense ratios to the extent possible,” said Amol Joshi, a distributor.

Fund houses have to disclose the TER of their schemes daily. Investors need to be informed via email or SMS at least three working days before any changes in the TER are effected.

When new TER limits were imposed last year, expenses came down, and it positively impacted returns. Conversely as and when the TER increases, the take-home gains for investors will decrease as well to the extent of the increase, said experts.

“Compared to the steep erosion in the NAV seen in the past two months, the impact of an increase in the TER on returns could be relatively much smaller,” Joshi said.

Returns of all major categories of equity schemes have seen an erosion of 21-24 per cent in the year-to-date. “There will be a marginal impact. Returns have already come off significantly, and a 10-20 basis points (bps) increase in the TER may not make a huge difference in the overall scheme of things,” added another person.

According to experts, the TER should not be the primary criterion for deciding on an equity fund. However, for schemes that come with a similar risk and return profile, lower expenses could prove to be an advantage.

The current TER structure was proposed by the market regulator in September 2018 with the objective of reducing portfolio churning and misselling. The earlier slab-wise limits of the TER were introduced in 1996. The Securities and Exchange Board of India had also clarified that the additional expenses of 30 bps for penetration in B30 (beyond top 30) cities could be charged only if the assets came from retail investors, and not corporates and institutions.