5 Best Active Equity Mutual Funds with Low Expense Ratio and High Returns

March 15, 2023 Mutual Fund

Before investing in mutual funds, a host of parameters need to be evaluated, and one of them is the Expense Ratio.

What is Expense Ratio in Mutual Funds?

Well, in simple terms, it is the charge levied by the mutual fund house for fund management onto the respective scheme and includes costs such as registrar fees, transfer fees, custodian charges, brokerage on buying and selling securities, agent commissions, legal and audit fees, management expenses, advertising, and marketing fees, maintaining proper records of investors, etc.

All these costs contribute to the fund’s expenses and are charged to you, the investor, as a Total Expense Ratio (TER). The TER is expressed as an annualised percentage of the fund’s net assets and is disclosed on a daily basis. It is nothing but a per unit cost of managing the scheme, which is charged to all unit holders in the scheme uniformly. The Net Asset Values (NAVs) that mutual fund houses disclose are, therefore, TER-adjusted. As an investor, you do not pay for expenses ratio separately.

How is the Total Expense Ratio or TER calculated?

The formula used to calculate TER is as follows:

Total Expense Ratio (TER) = (Total Expense of the Scheme during the period / Total Scheme Assets) x 100

It’s important to note that while the capital market regulator, SEBI has prescribed caps for mutual funds (equity and debt schemes), the TER may differ from one scheme to another, depending upon the cost of running and managing the fund (as long as the expense ratio is with the prescribed regulatory limits).

Table 1: SEBI Prescribed Mutual Fund TER structure for actively managed equity and debt schemes

(Source: www.sebi.gov.in) 

Recently, finding flaws and inconsistencies such as “splitting of transactions”, “churning of investments”, and “the way incentives were calculated”, SEBI, in a letter to the Association of Mutual Funds in India (AMFI), disallowed fund houses from levying additional expense ratios from B30 cities for the time being.

You see, TER cannot be the sole deciding factor to invest in mutual funds…

Don’t invest in any mutual fund scheme just because its expense ratio is low. In isolation, TER can never be the deciding factor; it can’t supersede the overall performance when it comes to mutual fund scheme selection. If the expense ratio is low, and if the scheme is efficiently managed, it may enhance the overall performance.

You see, a poorly managed scheme can have the lowest expense ratio, and it’s also possible that the best-managed scheme with a consistent performance record may have the highest expense ratio.

Usually, mutual fund schemes with large Assets Under Management (AUM) enjoy economies of scale, and thus their expense ratios are expected to be lower. But that doesn’t mean you should invest only in schemes with large AUM. This is because, it is often found that larger schemes, especially the ones investing in midcaps and smallcaps, become less nimble with growing AUM.

[Read: Should You Invest In A Mutual Fund Scheme Looking At Its AUM?]

Under the current challenging market conditions, it is important to choose a mutual fund scheme that justifies the expense ratio with an appealing long-term performance backed by robust investment processes and systems.

We analysed the performance of 231 actively managed diversified equity mutual funds and found that the average difference between the expense ratios of Direct Plans and Regular Plans was 1.23%-which is substantial. According to our estimates, every 0.25% difference in the expense ratio of a scheme fetches you Rs 4.5 lakh in 20 years. So, investing in Direct Plans of mutual fund schemes is the best way to keep costs low without compromising on potential gains.

Table 2: Schemes with low expense ratios

Data as on 28 February 2023
*Erstwhile known as IDFC Sterling Value Fund
(Source: ACE MF, PersonalFN Research) 

Performance of the same set of schemes across timeframes and on a risk-adjusted basis helped us pick winners from all prominent categories-largecap, flexicap, midcap, value funds, and ELSS amongst others.

Table 3: Some of the best-performing diversified equity mutual fund schemes with low expense ratios

(Data as of 9 March 2023)
*Erstwhile known as IDFC Sterling Value Fund
Returns are Point to Point and in %, calculated using the Direct Plan-Growth option
Returns over 1-year are compounded annualised; else absolute
Past performance is not an indicator of future returns.
*Please note, this table only represents the best-performing schemes based solely on past 3-yr returns, Sortino, and Low Expense Ratio. The table above is NOT a recommendation as such. Speak to your investment advisor for further assistance before investing.
Mutual Fund investments are subject to market risks. Read all scheme-related documents carefully.
(Source: ACE MF, PersonalFN Research) 

The integrated view of Table 2 and Table 3 reinforces our belief: AUM, expense ratio and scheme performance are less strictly co-related.

Let’s look at mutual fund schemes in the table above individually.

Equity Mutual Fund Scheme #1: Kotak Bluechip Fund

Launched in February 2003, Kotak Bluechip Fund aims to generate capital appreciation from a portfolio of predominantly equity and equity-related securities falling under the category of large-cap companies.

As of 28 February 2023, the equity assets accounted for 98.5% of the portfolio comprising of 57 stocks. The fund held 1.5% of the assets in cash and cash equivalents to take care of liquidity needs.

Table 4: Top-10 holdings of Kotak Bluechip Fund

Data as of 28 February 2023
(Source: ACE MF, PersonalFN Research) 

The weightage of largecaps, midcaps and smallcaps was 82.3%, 13.9%, and 2.3% respectively. Historically, the top-10 holdings of the fund have been index-heavy stocks, and as of 28 February 2023, top-10 holdings formed 46.3% of the portfolio.

The fund has largely stayed with the market themes but has also invested selectively in contra names. For instance, it got rid of some prominent consumer goods companies towards the end of 2020 but has been adding some IT stocks of late, perhaps finding value in them after a considerable decline.

The buy-and-hold strategy adopted by Kotak Bluechip Fund has helped it curtail the expense ratio to 0.64% under its Direct Plan, one of the lowest in the category.

Equity Mutual Fund Scheme #2: Parag Parikh Flexi Cap Fund

Launched in May 2013, Parag Parikh Flexi Cap Fund seeks to generate long-term capital growth from an actively managed portfolio primarily of equity and equity-related securities.

The fund adopts value-style investment strategies and has been following a buy-and-hold approach. It doesn’t hesitate to take bold cash calls in case it doesn’t find appropriate opportunities suitable to its investing philosophy. Currently, the fund is holding 12.5% of its portfolio in cash and cash equivalents.

The fund also invests in international equities and has benefited immensely by betting on some big tech companies listed abroad. And despite the present downturn in tech stocks, with global equities, it has managed to outperform broader markets and its category peers.

As of 28 February 2023, the portfolio of the fund comprised of 37 stocks and the equity component accounted for 86.1% of the portfolio. Overseas equities constituted 16% of the portfolio, and the fund invested 70.1% of its assets in domestic equities. The split between largecaps, midcaps and smallcaps was 58.3%, 4.2%, and 7.5% respectively.

Table 5: Top-10 holdings of Parag Parikh Flexi Cap Fund

Data as of 28 February 2023
(Source: ACE MF, PersonalFN Research) 

Of late, the fund has pared its positions in mid-sized tech companies along with some giant overseas stocks. It has added a few frontline Indian financial stocks, especially in the private banking space.

So far, the contra and value bets of the fund have done exceedingly well, thereby allowing it to stay ahead of its peers.

The weightage of debt instruments currently comprises 1.4% of the total assets.

Equity Mutual Fund Scheme #3: PGIM India Midcap Opportunities Fund

Launched in December 2013, PGIM India Midcap Opportunities Fund aims to achieve long term capital appreciation by predominantly investing in equity & equity-related instruments of midcap companies.

As of 28 February 2023, the portfolio of the fund comprised 44 stocks, accounting for 90.3% of the portfolio. Therein the midcaps, smallcaps, and largecaps held a weightage of 83.8%, 5.1% and 11.0%, respectively. The remaining 9.7% were debt and cash-and-cash equivalent assets, suggesting that the fund maintains cash balance to deal with unforeseen liquidity pressure and takes refuge if it doesn’t find suitable investment opportunities.

Table 6: Top-10 holdings of PGIM India Midcap Opportunities Fund

Data as of 28 February 2023
(Source: ACE MF, PersonalFN Research) 

In recent months, the fund offloaded expensive midcap IT stocks, some newly listed companies, overvalued consumer goods companies and cyclicals as well. The fund has added some beaten-down stocks that might have started looking attractive now on valuations. The fund has preferred to stay with larger midcaps during phases of high uncertainty and its tactical allocation to largecap has also come in handy in dealing with volatility.

[Read: How to Strategically Approach Equity Mutual Funds in Volatile Markets]

Equity Mutual Fund Scheme #4: Bandhan Sterling Value Fund

Launched in March 2008, Bandhan Sterling Value Fund (erstwhile known as IDFC Sterling Value Fund) aims to generate capital appreciation from a diversified portfolio of equity and equity-related instruments by following a value investment strategy.

As of 28 February 2023, the fund held a well-diversified portfolio of 56 stocks which together accounted for 93.4% of the overall portfolio. The remaining 6.6% were non-equity assets such as debt and cash-and-cash equivalents.

Table 7: Top-10 holdings of Bandhan Sterling Value Fund

Data as of 28 February 2023
(Source: ACE MF, PersonalFN Research) 

Following the sector-agnostic approach, the fund held 56.8% of its portfolio in largecap, while midcap and smallcaps accounted for 27.5% and 15.6%, respectively. The fund has demonstrated patience and perseverance to reap the benefits of value investing. As a result, it has generated superior risk-adjusted returns over the past few years.

Although the stock-picking process of the schemes has largely been bottom-up, it has avoided investing in overvalued sectors (being true to its value style). For instance, it has preferred to go light on midcap IT and has avoided investing in some popular export themes.

Equity Mutual Fund Scheme #5: Quant Tax Plan

Launched in March 2000, Quant Tax Plan endeavours to generate capital appreciation by investing predominantly in a well-diversified portfolio of stocks with growth potential.

As of 28 February 2023, the fund held a compact portfolio of 41 stocks, accounting for 98.4% of the portfolio. The remaining 1.6% were cash and cash equivalent assets.

Table 8: Top-10 holdings of Quant Tax Plan

Data as of 28 February 2023
(Source: ACE MF, PersonalFN Research) 

Although Quant Tax Plan has adopted a process-driven stock selection model, it hasn’t refrained from frequent churning and holding a top-heavy portfolio. During phases of strong economic growth and earnings upgrades, the fund has invested aggressively in small and mid-sized companies. However, in times of uncertainty, the fund has mitigated the risk by loading up the portfolio with largecaps.

As on 28 February 2023, the exposure of Quant Tax Plan to largecap was 78.0%, while midcaps and smallcaps accounted for 17.2%, and 4.5% of the portfolio respectively.

Usually, it is observed that lower churning helps mutual fund houses keep their expense ratios low. Quant Tax Plan is a rare exception. Despite the high churning of the portfolio, the expense ratio of its Direct Plan has been one of the lowest in the industry. The nimble approach has facilitated the fund to generate remarkable alpha in recent years and handsomely rewarded its investors.

To conclude…

Evaluate scheme options based on a variety of quantitative as well as qualitative parameters. Expense ratio and performance are quantitative parameters, but you should also care equally, if not more, about qualitative aspects such as the portfolio characteristics, the philosophy of the fund house and its investment processes and systems to name a few.

Also, you should keep in mind your risk profile, investment objectives, financial goals and time in hand to achieve the envisioned goals in mind while selecting any mutual fund schemes for your portfolio.

This article first appeared on PersonalFN here