With reference to an investment fund, expense ratio is the ratio of the fund’s operating expenses to its assets under management. It is calculated by dividing the fund’s operating expenses by the assets under management of the fund.
Expense ratio is also called mutual fund expense ratio.
Since operating expenses eat away at a fund’s return, expense ratio is an important parameter in selecting an investment fund. It is typically very high for actively-managed funds and low for passively managed index-tracking funds.
Many investment funds report their expense ratios in their fund manager’s reports, annual reports and on their websites.
|Expense ratio =||Operating Expenses|
|Assets under Management|
Operating expenses include management fee, which is the fee charged by the investment fund manager/advisor, legal and custodial fees, accounting and auditing fees, mutual fund marketing and distribution fees and any other fund related operating expenses.
There are two important expense categories which aren’t included in the definition of operating expense for expense ratio calculation. These include: (a) transaction fees related to trading of the fund investments and (b) such expenses which are borne directly by a unit holder of a mutual fund or exchange-traded fund (ETF), such as initial purchase fee of the fund units, redemption fee, etc.
Assets under management represent the value of investment assets of the fund minus any liabilities of the fund. Normally, average assets under management figure is used to calculate the expense ratio.
In some jurisdictions, regulators provide guidance on calculation methodology and stipulate a limit on the maximum expense ratio for different investment fund categories. In Pakistan, the Securities and Exchange Commission of Pakistan has issued directive to standardize calculation of total expense ratio. It requires inclusion of any government levy and taxes in the operating expenses. It defines assets under management as average net asset value (total value of investments minus any liabilities).
Following is an extract from the financial statements of Alfalah GHP Alpha Fund for the financial year ended 30 June 2016:
|Remuneration of management company||15,793,951|
|Sales tax on management fee||2,564,937|
|Sales tax on performance fee||302,319|
|Federal excise duty on management fee||2,527,033|
|Federal excise duty on performance fee||297,850|
|Remuneration of the Trustee||1,819,007|
|Sales tax on trustee fee||254,662|
|Annual fee to the regulator||868,147|
|Bank and settlement charges||418,318|
|Fees and subscriptions||263,982|
|Expenses allocated by management company||537,962|
|Total operating expenses||33,403,107|
Net assets of the fund at the start of the year and end of the year are PKR 801,220,136 and PKR 1,025,486,735 respectively.
Operating expenses include all expenses other than the expenses incurred in carrying out investment transactions. Of the expenses listed above, only the brokerage expense is an item which doesn’t fulfill the definition of operating expenses.
Operating Expenses = PKR 33,403,107 – PKR 4,917,288 = PKR 28,485,819
|Average Net Asset Value =||801,220,136 + 1,025,486,735||= 913,353,436|
|Expense Ratio =||28,485,819||= 3.12%|
Since it is an actively-managed fund, the expense ratio is quite high.