What is a Total Expense Ratio (TER)?
TERs were introduced to provide a common and therefore comparable way of disclosing the costs that are incurred within a unit trust fund. In other words, a TER is not a new cost or an additional cost, it is simply a measure of the actual costs that have been incurred while managing and operating the unit trust fund.
TERs enable investors to compare the underlying costs of different investment options by providing a measure of these costs. A practical example would be the difference in underlying cost that is incurred in a single-manager fund versus a multi-manager fund or Fund of Funds.
How to use TERs
Most statistics and measurements in financial services have limited application. This comment relates to the fact that many performance and fee measures are associated with a generic time-frame, which may be purely historic and is not specific to the length of time that you may hold an individual investment. This is not to say that they are worthless. They are very useful as an indicative measure. You should always view measurements and statistics within the context of their limitations and therefore should use such measures with caution and definitely not in isolation.
When you look at a fund, and specifically its TER, be sure to take into account the context of your overall goals and objectives, reasons for investing, and all fees and performance measures.
Why do TERs matter?
- They create greater transparency because they include all defined expenses that are actually deducted from the fund’s portfolio. This means that while the TER is expressed as a ratio or percentage, this is based on the actual historical costs that have been incurred.
- TER disclosure standards require investment managers to specifically disclose any performance fees.
- By industry agreement, TERs should be made available whenever a unit trust fund’s performance is published.
How is the TER calculated and what does it measure?
The total expenses incurred in running a fund are divided by the fund’s total assets to arrive at a percentage amount, which represents the TER.
A TER of 1.5% for the year will therefore mean that, assuming the fund achieved a gross return of 15% for the year before any costs, you as an investor will receive 13.5% as your return after costs (15%–1.5%).
Fund expenses included in the TER:
- The annual investment management fee including any performance-based investment management fees;
- The fund’s bank charges;
- The fund’s auditor’s fees;
- Taxes such as stamp duty and VAT;
- Custodian and trustee fees (custodians and trustees are appointed to protect the interests of the unit holders, and the fees are for their services); and,
- Any income retained from scrip-lending, and not passed back to the fund.
When it comes to Fund of Funds, the TER calculation includes the weighted TERs of the underlying funds or holdings, plus the cost of the Fund of Funds itself. This is why you may notice that the TER for a Fund of Funds tends to be higher than a single-manager fund.
Fund expenses NOT included:
- Initial investment fees (including any initial financial adviser fees) – these fees are deducted from the investment amount before units are bought;
- Annual adviser fees that do not form part of the annual management fee;
- Stockbroker fees – this is the cost incurred when buying and selling shares in the fund; and,
- Expenses related to the settling of transactions and taxes.
The challenges of using TERs as a measure of cost without context
As mentioned above, TERs are useful measures of the costs within a fund, but they have their limitations.
- A TER is not a measure of ALL costs incurred when you invest. In this way, the name “Total” Expense Ratio could be misleading. A TER is only a measure of the costs incurred when utilising the unit trust structure itself. You still need to take into account any other fees such as any LISP administration fee or fees for financial advice that are not included in the annual management fee. As opposed to TER, the life assurance industry uses a different calculation called a “Reduction in Yield”. This makes it difficult to compare unit trusts with other types of investments across the savings and investment industry.
- The TER is calculated using historical actual costs. This means that a TER may not necessarily be an indication of future expenses.
- The calculation applies to a full financial year, and to get the actual costs and publish these, any published TER is lagged by at least a quarter, which means it is unlikely to correspond exactly to your specific investment period. A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return.
