The TER is a cost index that includes the commissions applied to the investor’s return in mutual funds and ETFs. How is it calculated and what expenses does it include?
Costs can significantly erode the returns on investments: when choosing the financial instrument to invest in, it is necessary to carefully evaluate the cost of expenses and commissions on the investment. To this end, the TER helps us, which defines the percentage of cost to expect.
In this article, we’ll see what is the TER, how it is calculated, and what the inclusive expenses are in the commissions charged to the investor’s profits.
TER: what is it
The TER - total expense ratio (total expense ratio) - is a cost indicator and measures the total costs resulting from the management and operation of an investment fund, such as mutual funds or ETFs.
The costs indicated by the TER mostly derive from management costs and additional expenses, such as legal costs, audit fees, and other operational costs.
According to Consob:
The TER is an important indicator which, simply and effectively, represents the percentage of assets "actually" liquidated by the fund in a given period for the total of commissions and costs. It is also a useful comparison tool between multiple funds.
Calculation of TER
The total cost of the fund is divided by the total assets of the fund itself to define a percentage, which represents the TER, more often simply referred to as "expense ratio".
TER = (Total Fund Cost / Total Fund Assets) x 100
The importance of TER
The amount and size of the TER are crucial factors since the real cost of investing in a fund necessarily affects the investor’s profits.
For example, if the fund generates a profit of 5% per year but its TER is 3%, then the return decreases significantly for the investor until it reaches 2%.
The TER defines the amount of annual costs for managing a given fund: it takes all the known costs associated with the fund’s operations and collects them into a single number, generally in the form of a percentage based on the assets associated with the fund. This means that the amount of TER provided is strictly proportional to the performance of the fund.
| Type of cost | % of TER | Reason |
|---|---|---|
| Management fees | 85% | Useful to compensate fund employees and manager |
| Deposit fees | 5% | For safekeeping of the capital raised by the fund at the reference bank |
| Performance fees | 10% | Possible and never present in ETFs, it applies when the fund’s performance exceeds that of the benchmark or the levels predetermined in the prospectus |
| Administration fees | <1% | To include legal costs, advertising and administrative costs |
The collection through the TER is used by the investment fund to support the management fees and legal fees associated with the fund, as well as for any audit fees or general management expenses.
Whenever a fund has higher or lower operating expenses, those changes usually impact the TER. The more actively managed the fund, the higher the associated TER. This is due to increased personnel costs, as well as higher transaction rates. In contrast, an automated fund has significantly lower operating costs, resulting in a lower TER.
The operating expenses, or operational costs, cover the outgoing financial obligations associated with the management of the fund and related transactions. These can include employee salaries and brokerage commissions, as well as accounting-related expenses. Other common expenses include shareholder communications and financial statement releases, recordkeeping mechanisms, and custodian services from the supervisory body or asset manager.
A small portion of the TER can be used to cover other business management costs, such as renting buildings or business assets.
Among the costs charged by the funds through the TER, the following must not be included:
- tax costs
- subscription fees
- switching and trading fees
Original article published on Money.it Italy 2017-06-20 10:57:49. Original title: TER: cos’è e come si calcola il costo degli investimenti in fondi?
