Gross Expense Ratio – What it is and How it WorksFebruary 18th, 2013 by David Waring
The Gross Expense Ratio (GER) is the percentage of a fund’s assets that are taken out as payment for managing the fund. It excludes certain trading expenses, like brokerage fees which are incurred whilst trading the portfolio. These and other costs have to be reported in a Statement of Additional Information (SAI) which is filed annually with the SEC. You can usually download a copy of your SAI, directly from your funds website.
How It Works
It’s important to understand that the gross expense ratio is an annual fee for managing the fund and is completely separate from the sales fee, which is only paid upon the purchase of the fund.
On average the gross expense ratio for an actively managed mutual fund is around 1.5%. But this can vary greatly from fund to fund, so make sure you do your homework.
The amount you pay is also related to the type of fund you buy. Actively managed funds for instance, typically charge more than passively managed funds, due to the extra charges incurred actively managing the fund. But the actively managed funds performance should more than compensate for this. If not, you have some serious questions to ask your funds manager.
What makes up the gross expense ratio:
- Management fee: – Sometimes called an advisory fee, generally makes up around 0.50% to 1.00% of the fund’s total assets. This is what pays for your fund managers personal art collection and corporate jet.
- Administrative fee: – This generally makes up between 0.20% and 0.40% of the fund’s total assets. It covers costs which aren’t covered by the management fee, such as office rental and electricity, as well as corporate lunches and private secretaries. (Beware of excessive administrative fees.)
- Advertising fees: – Otherwise known as 12b-1. This is to cover the cost of marketing the fund, it typically ranges from 0.25% to 1.00% of the fund’s assets. You might be wondering why you have to pay for this, surely the cost of marketing the fund should be borne by the fund manager? But it’s generally believed that by marketing a fund, its assets will increase over time and management can therefore lower expenses due to increased economies of scale, benefiting all of the funds investors.
Fee Waivers and Reimbursements
Sometimes funds partially cover the costs of their own operations. In which case they’ll either waive fees associated with operating costs or reimburse investors. This is done to keep the funds pricing competitive.
This is usually the case for smaller funds where investors own a much larger percentage of the fund than investors in larger funds. Because of this, each investor pays a higher percentage of operating costs and thus reaps a smaller profit from the investment. Smaller funds’ therefore use waivers and reimbursements as an incentive to investors.
Gross Expense Ratio vs. Net Expense Ratio
Don’t confuse the gross expense ratio with the net expense ratio. The net expense ratio equals the gross expense ratio of a mutual fund excluding any fee waivers or reimbursements made to investors.
The gross expense ratio considers all of the expenses of a fund, including administrative and accounting costs associated with investments made by the fund. The gross expense ratio has to be published by the mutual fund, whereas the net fund ratio does not.
If you’re looking to invest in a fund you should look at both the net and gross expense ratios. A high gross expense ratio doesn’t always mean a high net ratio and vice versa, but looking at both should provide you with a good idea of the expenses involved managing the fund.
Expense ratios vary greatly, from fund to fund , so make sure you read the prospectus of each fund carefully. It’s also important to compare the expense ratios to similar mutual funds from competing companies to determine if the fee’s are competitive.
Why Does it Matter
Many people don’t even bother to look at the gross expense ratio when choosing a fund, they focus on the return instead. This is a mistake and I’ll show you why. If your fund has a total return of 8% over the preceding 10 years and has a gross expense ratio of 1.8%, you’ve effectively only made 6.2% per year net.
Compare that to a fund which has an average return of 7.5% over a ten year period, but has a gross expense ratio of only 1%. You now have a net return of 6.5%. This is a simplified example but you get the idea. It’s a good idea to compare fees and return rates to work out your net return.