Have you bought mutual funds before? Did you pay any fee or charge? I believe you noticed the sales charge. Some of you might say you did not even pay for this as your fund waives it. So, is sales charge the only fee? Or, if it is waived, are you really buying it for free? The answer is a big NO. There are other fees involved if we hold mutual funds in our portfolio.
Mutual fund fee structure
Fees and charges can be categorized into two types: direct and indirect. Direct fee is the charge that we need to pay out of pocket. This is the fee that we knowingly pay. Indirect fee is usually deducted from the fund itself. As the transaction happens without our knowledge, you might not notice this fee.
According to Guidelines on Unit Trust Funds [SC-GL/GUTF-2008(R1-2016)] issued by Securities Commission Malaysia, a mutual fund is allowed to charge the following items.
| Fee/Charge | Normal Rate | Note |
|---|---|---|
| Direct Fees | ||
| Sales Charge | 0 – 7% of investment amount | - Payable during every purchase/top up - Exempted for dividend reinvestment - May be waived by some funds |
| Repurchase Charge | 0 – 2 % of redemption amount | - Payable when you sell the fund - Only levied by certain funds |
| Switching Fee | Variable | - Only applicable if you switch from one fund to another |
| Indirect Fees | ||
| Annual Management Fee | 1 – 2% of net asset value (NAV); lower in bond funds | - Charged by fund manager for management of the fund |
| Annual Trustee Fee | 0.04 – 0.1% of NAV | - Charged by the trustee for the provision of custody services for the fund’s assets |
| Other Expenses | Variable | - Expenses directly related and necessary in operating and administering a fund. These include: 1. Brokerage fees 2. Custody fees 3. Taxes 4. Accounting and valuation fees 5. Audit fees 6. Administrative costs 7. Others related costs |
Composite ratio
For the indirect fees, there is a ratio known as expense ratio that captures all these fees. The following definition is from Investopedia:
“The expense ratio is a measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual calculation, where a fund’s operating expenses are divided by the average dollar value of its assets under management (AUM). Operating expenses are taken out of a fund’s assets and lower the return to a fund’s investors. It is also known as the management expense ratio (MER).
(Investopedia Definition Link)”
Expense ratio informs investors regarding the total costs of having the fund managed. This ratio also allows comparison among funds with different cost structures. In short, this is the ultimate ratio that we can use to represent the indirect fees. Expense ratio is computed annually.
The expense ratio of mutual funds in Malaysia generally ranges between 0.5 – 2.5% of NAV. However, in some funds, it can be significantly higher.
How do the fees affect our profit?
It is easier to explain with an example. Let’s say I want to buy Fund A with RM 1000. Its sales charge is 5% and expense ratio is 1.8% (including annual management fee, annual trustee fee and other expenses). Let’s assume that the fund does not make any profit after 1 year.
| Initial investment | RM 1000 |
| Less: Sales charge | RM 1000 x 5%
= RM 50 |
| Actual investment | RM 950 |
| Less: Annual fund expense | RM 950 x 1.8%
= RM 17.10 |
| Value after 1 year | RM 932.9 |
As you can see, you have lost more than 6% before earning any money. Thus, the fund has to make more than 6% returns for us to break even. It is possible but not easy.
For easier computation, we can roughly know our upfront expense by adding up all stated fees and charges. Using the earlier example, upfront expense will be around 6.8% (sales charge and expense ratio). The expense will be even higher if the fund has a repurchase charge. Luckily, there are not a lot of funds that levy this charge.
Conclusion
How do you feel about mutual funds now? Disappointed? Actually, if the fund can produce spectacular returns, the fees (if they are not outrageous) are justifiable. Nonetheless, I will suggest you to find a fund with a lower fee structure. If two funds have the same performance, the lower-fee fund will outperform the other. There is a platform known as Fundsupermart (Link) that has a low sales charge. I suggest you to use this platform if you want to invest in mutual funds. Every cent saved is one cent gained!
