Mutual Funds

Expense Ratio

The expense ratio of a mutual fund is the annual fee you pay to the AMC for the management and operation of the investment fund. It is generally expressed as a percentage and includes the fund’s annual operating expenses like portfolio management fees, marketing expenses, and allocation charges. While the expense ratio of a fund depends on the total assets under management, a lower expense ratio is better as it means lower investment costs. You do not need to pay the expense ratio separately since it is deducted from the investment value daily.

 

For example, if you invest Rs. 5,000 in a mutual fund with an expense ratio of 2%, then (2% / 365=0.0054%) will be deducted from the investment value each day. The per-day levying of the expense ratio ensures that you only pay for the period you stay invested. But this deduction of the expense ratio is lowering your returns by a tiny amount every day. Hence, a mutual fund scheme with a lower expense ratio is more beneficial to you because it takes away a lesser portion of money from your returns.

Expense Ratio Formula

Total expense: The costs incurred by the AMC mentioned above like fund manager’s fee, marketing, and distribution expenses, legal / audit costs

Average AUM: The total value of all investors’ money in that fund

Regulatory Framework

The Securities and Exchange Board of India (SEBI) serves as the regulatory authority for mutual funds in India. SEBI's purview extends to overseeing the entire lifecycle of mutual fund operations, from their inception to administration. This regulatory oversight aims to safeguard investor interests and maintain market integrity by ensuring fair and efficient practices within the mutual fund industry.

As a regulator of mutual funds, SEBI also requires that most of the directors on the board of trustees and half of the directors of the AMC be independent. This means they shouldn’t be connected to the sponsors. Through many such rules and restrictions, SEBI ensures that the mutual fund is managed fairly and transparently.

Mutual funds' regulation framework

Regulatory framework for the mutual funds industry includes:

• Fund distribution
• Client grievance handling and redressal
• Objectives and strategies of investment
• Selection of AMCs (Asset Management Company)
• Disclosure norms by the AMCs
• Valuation of assets

To ensure compliance with mutual funds regulations, SEBI issues directives from time to time and also takes necessary actions to safeguard investors' interests.

By laying down strict laws and regulations for the mutual fund industry, SEBI bolsters investor confidence, on the one hand, and fosters sectoral development, on the other. In this way SEBI plays an important role in overseeing and regulating the mutual fund landscape.

All these steps ensure that transparency is maintained in the mutual fund market.

Things to keep in mind before investing in mutual funds

Making investments in mutual funds can be tricky. Given the number of schemes and the associated types, it is necessary to consider several key factors so that you can pick funds that align with your financial goals and risk tolerance. Below are some important things to consider before investing for a more successful investment experience:

1. Analysing one’s own financial situation

Before investing in mutual funds, it’s important to thoroughly understand your financial situation. Start by defining your investment goals, which includes determining:

• How long do you plan to invest
• How much risk you can handle
• What returns do you expect

Once you have clear goals, you can create a strategy to allocate your assets appropriately. By making this strategy beforehand, you can better decide how much of your money will go into different types of investments, such as stocks, bonds, and cash. Also, it will help you achieve a balanced and suitable investment portfolio.

2. Do research on the relevant schemes

Doing extensive research is crucial before investing in mutual funds. Below are some key aspects you can consider:

• Performance history: Look at how the mutual fund has performed over time. This can give you an idea of its potential future returns. Compare its past returns with its benchmark index to evaluate its performance.
• Fund manager’s track record: Check the experience and past performance of the fund manager. Be aware that a good fund manager with a solid track record can significantly impact the fund’s success.
• Reputation of the fund house: Investigate the fund house’s history, corporate governance practices, and regulatory compliance.
• Expense ratio: This is the fee the mutual fund charges for managing your investment. Compare the expense ratios of different mutual funds to find the best value for your money. The lower the expense ratios, the higher the mutual fund returns.

3. Investment portfolio diversification

Diversification involves spreading your investments across various asset classes and sectors to reduce risk. In mutual fund investing, diversification is the key. It minimises portfolio volatility and protects against market fluctuations. You can diversify by investing in a mix of equity (stocks), debt (bonds), and hybrid funds. Now, within each asset class, further diversify by investing in different industries and sectors to avoid concentration risk.

4. Keep your portfolios clear of unnecessary clutter

Having too many mutual funds in your portfolio can create difficulties in management and lead to overlap in investments. Therefore, focus on building a well-diversified portfolio with a few carefully selected mutual funds. This makes it easier to monitor and manage your investments effectively.

5. Putting a timeframe on the investment

Decide how long you plan to hold your mutual fund investments. This timeframe should align with your risk profile and investment goals. It is worth mentioning that for shorter investment horizons, debt mutual funds might be more suitable as they offer lower risk. On the other hand, for longer investment horizons, equity mutual funds can provide higher returns, though they come with higher risk.