Lion Global Investors Unveils Active Managed Low Expense Ratio Fund: What Is Expense Ratio?

Lion Global Investors, one of the largest asset management firm in Southeast Asia, has unveiled a one of a kind actively managed fund for Singapore-dollar investors. What makes the fund stand out in a field filled with options is the fact that it allows investors to invest in a diversified, balanced portfolio of funds and exchange-traded funds at an uncommonly low expense ratio.

The selling point of the fund being the low expense ratio begs the question, what is the expense ratio and why should investors pay close attention to it?

What is the Expense Ratio?

In layman terms, expense ratio is the amount of money that investment companies charge investors for managing funds. Also known as, the management expense ratio, the metric measures the amount of money used for administrative and operating expenses.

Expense ratio is normally expressed as a percentage of asset subtracted annually, to fund expenses incurred by management in running a fund. In most cases, portfolio transactions fees, as well as brokerage fees, are never included in the computation of expense ratio.

Expense ratio varies depending on the fund and the management at the helm. However, it tends to be relatively stable. The amount of money paid to investment managers and advisors tends to account for a considerable chunk of expense ratio in most funds.

Expense Ratio Components

Expense ratio is computed using three main measures, administration costs, advertising costs as well as management costs.

Management fees

Funds appoint highly experienced managers and task them with the responsibility of coming up with investment strategies designed to beat the market and generate significant returns depending on capital invested. The managers usually charge a fee which in most cases ranges between 0.05% and 1% of the total fund’s assets.

Administrative costs

These are the costs incurred in the running of the fund. They include costs for record keeping, customer support as well as for service and communications. Given that the costs vary greatly, they can be expressed as a percentage of the fund.

12-1b Distribution Fees

12-1b Distribution fees are costs used to advertise and promote a fund

Other miscellaneous costs that may come into being include legal expenses as well as accounting and auditing costs. Most of the costs that account for expense ratio are variable expenses but fixed within a given range.

Calculation of Expense Ratio

Expense ratio is calculated by dividing a fund’s operating expense by the average value of a fund’s assets.

Expense Ratio=

Costs not incurred in the day to day running of fund are never included in the calculation of expense ratio and so are costs incurred in trading. Onetime costs such as a sales commissions are also not included in the computation of expense ratio.

Assuming an investor has invested $50,000 in a fund with a total investment of $1,000,000. If the expenses incurred to operate the fund at the end of the year totaled $50,000, then the expense ratio will be

Expense ratio= X 100= 5%

What this means is that the investor will be billed $2,500 as expenses incurred in operating the fund. If the fund earned more than the $50,000 as expenses, then the investor is sure to walk away with some returns.

A lower expense ratio is thus important for amplified returns, as expenses significantly affect returns. Higher expense ratio means less profitability.

Index funds come with low expense ratio in part because they are passive investment funds that try to mimic the performance of an underlying index. Management fees associated with these funds tend to be minimal.

Mutual Funds being actively managed funds are associated with higher management fees, which most of the time affect their returns. It is for this reason that most of them tend to underperform the broader market.

Importance of Expense Ratio

Expense ratio measures how effectively a fund is managed when it comes to operating costs. A higher rate is most of the time indicative of a fund that is spending too much money relative to assets to generate returns. A lower ratio, on the other hand, indicates that fewer expenses are being incurred to measure the same amount of assets.

Investors should always consider expense ratio prior to making any investment decision into a fund because such costs can considerably impact the net profitably of a fund. If a fund makes a return equal to 16% and has an expense ratio of 3%, then it means each investor will earn a return equal to 13%. A lower rate thus means more returns in terms of profits to investors.

Expense ratio can also be used to determine if a fund is actively or passively managed. In the case of actively managed funds, the ratio tends to be high given that the managers must be paid for their service. Passively managed funds tend to have low rates as they are not actively managed. Instead, they try to track the performance of an underlying index.

A high expense ratio is not entirely a bad thing, and such funds won’t always give low returns. Funds that are managed aggressively can also generate high returns relative to their costs depending on the choice of investment as well as selected stocks or assets.

Bottom Line

Lion Global Investors has set a new benchmark In Singapore when it comes to the amount of costs that investors should incur in funds. A fund with an expense ratio capped at 0.5% per year should be a no-brainer to investors who cherish low costs funds, given that some funds charge as much as 4% per year.

To achieve low costs operations, the fund has successfully persuaded service providers and distribution channels to lower their costs. In a bid to trim the operations costs, the new fund is to be distributed via online channels. The new low expense ratio fund will also be using passive index ETF to gain exposure into the U.S and European stock markets in a bid to lower costs, while targeting higher returns.