Definition
The expense ratio is a fund's annual operating costs, such as management, administration and custody fees, expressed as a percentage of its average net assets. It is deducted from the fund's assets, so it lowers returns without appearing as a separate bill.
How it works
Costs accrue daily and are built into the NAV, so reported fund returns are normally already net of them. Fund documents use different labels, such as total expense ratio, ongoing charges figure or, in Hong Kong key facts statements, ongoing charges over a year, and the costs they include can vary.
The ratio is charged every year on the whole balance, so small differences compound over time, and it is a known cost while returns are uncertain. It generally excludes brokerage, spreads, taxes and one-off sales charges, so the total cost of holding a fund can be higher.
Formula / convention
Expense ratio = Annual operating expenses ÷ Average net assets × 100%
Illustrative example
Illustration with fictional figures: a fund with average net assets of HK$500 million and annual operating costs of HK$2.5 million has an expense ratio of HK$2.5 million ÷ HK$500 million = 0.50%. On a HK$100,000 holding that is about HK$500 a year, taken from the fund's assets, compared with about HK$200 in a fund charging 0.20%.
What to watch for
A low expense ratio does not guarantee better performance, and the ratio leaves out trading costs, spreads and sales charges. Compare funds with the same strategy and read what the figure includes.