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Are low-cost funds best options available out there?

Henil Shah
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Are low-cost funds best options available out there?

According to the study carried out by Vanguard, low-cost funds tend to perform better than those bearing the high cost. Now, you might be thinking as to how does cost matter while investing? 

 

Why cost matter? 

Though the cost while investing seems to be no big deal, the costs add up in a similar manner to how your returns compound. The problem is not with the small amount that you lose in the form of the expense ratio that you pay, but it is about the growth that you lose for that extra penny you pay. Suppose the expense ratio of Fund A is 0.5 per cent and that of Fund B is a mere 0.1 per cent, though the difference of 0.4 per cent seems to be low, you are losing all the growth that you might have had for years into the future by investing those 0.4 per cent. 

Say, for instance, you have invested Rs 1 lakh in a fund that earns 10 per cent a year for the next 25 years and had no expense ratio, you will end up having close to Rs 10.83 lakh. 

Now, say, if you had to pay 1 per cent a year in costs, post 25 years, you would have only accumulated about Rs 8.43 lakh. 

Yes, you read that right! A mere 1 per cent you paid every year would wipe out almost 22 per cent of your accumulated value. So, now, one per cent might not sound small right? 

However, the question is whether does it make sense to select funds solely based on the expense ratio? We shall find out by carrying out a study by comparing the returns of funds with a lower expense ratio with that of funds carrying a higher expense ratio. In order to do this, we would be simply analysing the expense ratio and three-year trailing returns of all the equity funds. 

 

Fund Name 

3-year returns (per cent) 

Lowest TER 

ICICI Prudential Passive Strategy Fund (FOF) - Direct Plan 

9.45 

0.02 

Tata Index Nifty Fund - Direct Plan 

12.03 

0.05 

Tata Index Sensex Fund - Direct Plan 

13.02 

0.05 

SBI Nifty Index Fund - Direct Plan 

11.72 

0.09 

HDFC Index Fund Nifty 50 Plan - Direct Plan 

11.92 

0.10 

 

Fund Name 

3-year returns (per cent) 

Highest TER 

Taurus Flexi Cap Fund - Direct Plan 

3.04 

2.63 

Taurus Largecap Equity Fund - Direct Plan 

6.56 

2.54 

Taurus Ethical Fund - Direct Plan 

13.41 

2.45 

Quant Consumption Fund - Direct Plan 

15.77 

2.38 

Quant Infrastructure Fund - Direct Plan 

15.55 

2.38 

 

In the above table, we have listed three-year trailing returns of the funds with the lowest as well as highest total expense ratio (TER). If we see, there seems to be no such positive correlation between the expense ratio and the performance of the funds. For instance, Quant Consumption Fund and Quant Infrastructure Fund performed better than the top five funds with the lowest TER despite having one of the highest TERs. 

Further, we carried on two rankings wherein first, we ranked funds based on three-year rolling returns and secondly, we ranked funds based on their TER. Lowest TER gets a higher rank while the highest returns get the highest rank. 

 

Rank based on three-year trailing returns 

Rank 

Fund Name 

3-Year Returns (per cent) 

Expense Ratio 

PGIM India Global Equity Opportunities Fund - Direct Plan 

33.22 

1.33 

Tata Digital India Fund - Direct Plan 

30.73 

0.94 

ICICI Prudential Technology Fund - Direct Plan 

29.85 

1.41 

Aditya Birla Sun Life Digital India Fund - Direct Plan 

29.10 

1.28 

Franklin India Feeder Franklin US Opportunities Fund - Direct Plan 

27.57 

0.55 

 

Rank based on Total Expense Ratio 

Rank 

Fund Name 

3-Year Returns (per cent) 

Expense Ratio 

ICICI Prudential Passive Strategy Fund (FOF) - Direct Plan 

9.45 

0.02 

Tata Index Sensex Fund - Direct Plan 

13.02 

0.05 

Tata Index Nifty Fund - Direct Plan 

12.03 

0.05 

SBI Nifty Index Fund - Direct Plan 

11.72 

0.09 

ICICI Prudential Sensex Index Fund - Direct Plan 

12.87 

0.10 

 

The above two tables clearly show that there is no correlation between the lower expense ratio and the highest returns. As we can see, those funds ranked on the basis of three-year trailing returns having expense ratios higher than that of those funds that are ranked based on TER. 

Therefore, investing in funds just because its TER is low, makes no sense at all. Researching and investing in good funds is not a piece of cake. Hence, we would recommend investors take a holistic view before investing in mutual funds. 

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1 comments on article "Are low-cost funds best options available out there?"

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GANAPATHY SASTRI

India is at least 20 years behind USA in developing ETFs.

In India ETF is a beautiful product that one can NEITHER buy NOR sell.

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