Do High TER Funds Pay Higher MFD Commission

A higher Total Expense Ratio (TER) in a mutual fund does not necessarily mean that the Mutual Fund Distributor (MFD) will receive a higher commission. Many MFDs often wonder: "Do mutual funds with a high TER pay higher commissions to MFDs?" It is important to understand that the TER represents the total expenses of a fund, whereas the commission is determined based on terms set by the Asset Management Company (AMC). Grasping this distinction is essential for making informed decisions.

What Is TER in Mutual Funds, and What Does It Include? 

TER (Total Expense Ratio) represents the costs incurred in running and managing a mutual fund. This can include expenses related to fund management, administration, marketing, and distribution. It is expressed as a percentage of the fund's total assets.

These expenses impact the mutual fund's NAV (Net Asset Value). Consequently, assuming all other factors remain constant, the returns received by an investor may be lower after accounting for these expenses.

To understand TER, it is necessary to know the meaning of these terms:

Example: If a mutual fund has a TER of 1.50%, it does not mean that the MFD (Mutual Fund Distributor) receives a 1.50% commission. The TER includes various types of expenses, whereas the MFD's commission depends on the commission rate applicable by the AMC (Asset Management Company) and the terms of payment.

How Do Mutual Fund Distributors Earn Commission in India? 

In India, Mutual Fund Distributors (MFDs) primarily receive a 'trail commission' from an Asset Management Company (AMC) on eligible investments made through them under a 'Regular Plan.' This commission depends on the eligible investment amount and the commission rate applicable by the AMC.

What is a trail commission?

A trail commission is a payment made by an AMC to an MFD for eligible investments facilitated by the latter. It is typically paid periodically, and the rate is determined by the AMC’s commission structure. An MFD's earnings can vary based on the investment amount and the applicable rate.

Who pays the commission to an MFD?

MFDs receive their commission directly from the AMC. This payment is subject to applicable regulations and the expense limits of the scheme. A typical investor, when investing through a Regular Plan, does not need to pay the MFD’s commission separately to the AMC; it is already factored into the scheme's expense structure.

Do all AMCs offer the same commission?

No, commission rates are not necessarily the same across all AMCs. Rates can vary depending on the specific scheme and the applicable payment terms. Therefore, one cannot accurately estimate an MFD's commission simply by looking at a mutual fund's Total Expense Ratio (TER). To determine the actual rate, one should refer to the latest commission information provided by the respective AMC.

What factors influence an MFD's earnings?

An MFD's earnings are primarily influenced by the following:

• Eligible investment amount: The value of the investment on which a commission is payable.

• Commission rate: The rate applied by the AMC.

• Changes in investment: Additional investments or redemptions can alter the eligible amount.

• Market fluctuations: Market performance can affect the value of the investment and the eligible Assets Under Management (AUM).

• Payment terms: The AMC’s commission structure and its associated rules.

Do MFDs receive a commission on every investment?

No. A commission is not necessarily paid on every investment. For instance, in the case of a 'Direct Plan,' the distributor does not receive any distribution commission. According to AMFI guidelines, MFDs (Mutual Fund Distributors) do not receive commissions on their own personal investments.

How can MFDs check their actual commissions?

MFDs can review the latest commission rates provided by the respective AMCs (Asset Management Companies) and examine their own commission statements. This helps in understanding which rates apply to specific schemes and the actual amount paid out.

Investors can also view details regarding the actual commissions paid by an AMC on their investments in their half-yearly Consolidated Account Statement (CAS).

Does a Higher TER Mean a Higher Commission for MFDs? 

No, a higher Total Expense Ratio (TER) for a mutual fund does not necessarily mean that the Mutual Fund Distributor (MFD) will receive a higher commission from that fund. The TER reflects the total expenses of the fund, whereas the MFD's commission depends on the commission rate applicable by the Asset Management Company (AMC) and the eligible investment amount.

Why might the commission be lower even when the TER is higher?

A higher Total Expense Ratio (TER) for a fund can be attributed to factors such as fund management, administration, and other applicable costs. Therefore, one cannot determine how much commission an Asset Management Company (AMC) is paying to a distributor simply by looking at the TER.

Example : 

In this example, Fund A has a higher TER, but it generates a higher estimated commission than Fund B, because its assumed commission rate is higher.

How is an MFD’s commission calculated?

Let’s look at a simple example. Suppose an MFD has an eligible investment amount of Rs. 10 lakh, and the applicable annual trail commission rate is 0.50%.

Calculation:

Rs. 10,00,000 × 0.50% = Rs. 5,000 per annum

Based on this, the estimated annual commission would be Rs. 5,000, provided that the eligible investment amount and the commission rate remain constant throughout the year.

The actual payout may vary due to fluctuations in the market value of the investments, new investments or redemptions, and the specific terms and conditions set by the AMC.

How should an MFD determine the correct commission rate?

An MFD should review the latest commission information provided by the respective AMC, as well as their own payout details. Additionally, the fund’s Total Expense Ratio (TER) can be verified separately on the official AMFI website.

TER vs MFD Commission: What Is the Difference? 

TER and MFD commission are interconnected, yet they have different meanings. TER represents the total applicable expenses of a mutual fund, whereas MFD commission is the payment made by an AMC to a distributor on eligible investments.

Practical Calculation: How Much Commission Can an MFD Earn? 

The commission earnings of an MFD depend primarily on the eligible investment amount and the applicable trail commission rate of the AMC. According to AMFI, mutual fund distributors receive trail commissions from AMCs on eligible investments in 'Regular Plans', which are typically paid out on a monthly basis.

Formula for calculating MFD commission

Estimated annual commission = Eligible investment amount × Annual trail commission rate ÷ 100

Please note that this is a simple estimate. The actual commission may vary based on the AMC’s calculation methodology, eligible AUM, and applicable payment terms.

Example: How much commission would be earned on an investment of Rs. 10 lakh?

Suppose an MFD has an eligible investment amount of Rs. 10,00,000, and the AMC’s applicable annual trail commission rate is 0.50%.

Calculation: Rs. 10,00,000 × 0.50 ÷ 100 = Rs. 5,000 per annum

If the eligible investment amount and the commission rate remain constant throughout the year, the average monthly commission would be approximately Rs. 416.67.

Comparison of earnings at different commission rates

The figures provided below are solely for the purpose of illustrating the calculation and do not represent the commission rates of any actual AMC.

What factors can cause the actual commission to change?

• Changes in eligible AUM: Fluctuations in the value of investments can affect the commission.

• Investments and redemptions: Additional investments can increase the eligible amount, while redemptions can decrease it.

• AMC commission rates: Different rates may apply to different schemes.

• Eligibility and payment terms: Not every investment is necessarily eligible for a commission.

Regular vs Direct Mutual Funds: How Does Commission Affect TER? 

The primary difference between 'Regular' and 'Direct' plans of a mutual fund lies in the distribution costs. Consequently, both plans have different Total Expense Ratios (TER) and Net Asset Values ??(NAV), even though they share the same investment portfolio and fund manager.

Why is the TER higher for a Regular Plan?

In a Regular Plan, an investor invests through a mutual fund distributor (MFD). The distribution costs and the distributor's commission are included in the scheme's expenses. For this reason, the TER of a Regular Plan is higher than that of the corresponding Direct Plan.

Why is the TER lower for a Direct Plan?

In a Direct Plan, an investor invests without the involvement of a distributor. Since no distributor commission is paid, the TER is lower compared to the corresponding Regular Plan. However, a Direct Plan still incurs costs related to fund management and other applicable expenses.

Comparison of Regular and Direct Plans

How does the difference in TER affect an investor's returns?

Suppose a scheme’s gross return is the same for both plans, but the Regular Plan has a higher TER. In such a case assuming all other factors remain constant an investor’s returns (net of expenses) could be higher in a Direct Plan.

However, this does not necessarily mean that investing through a Direct Plan is the best choice for everyone. Investors should also consider the extent to which they require investment-related advice and ongoing service.

Conclusion

Mutual funds with a high Total Expense Ratio (TER) do not always offer higher commissions to Mutual Fund Distributors (MFDs). Commissions depend on the rates applicable by the Asset Management Company (AMC), the nature of the eligible investments, and the specific payment terms. Therefore, MFDs should not base their decisions solely on the TER; they should also review the official commission disclosures. Meanwhile, when selecting a fund, investors should prioritize factors such as costs, risk, and their own financial goals.

FAQs

Q1. Do High TER Mutual Funds Pay Higher Commissions to MFDs?

No, a higher TER does not mean a higher commission. The commission depends on the rates applicable by the AMC and the eligible investments.

Q2. What Is TER in Mutual Funds?

TER (Total Expense Ratio) represents the total expenses incurred in operating and managing a mutual fund.

Q3. How Do MFDs Earn Commission from Mutual Funds?

MFDs receive a trial commission from the AMC on eligible investments in 'Regular Plans,' in accordance with the applicable terms and conditions.

Q4. Does a Higher TER Mean Better Returns for Investors?

No, a higher TER does not guarantee better returns. One should also consider expenses, risk, and the fund's performance.

Q5. Do MFDs Earn Commission on Direct Mutual Funds?

No, no commission is paid to distributors for 'Direct Plans.'