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A high-cost fund can be a good buy

Don't invest in a scheme just because it charges a lower annual fund management fee.

Rule: High annual expenses charged by some funds eat into the returns of the investors.

Exception: If the fund has been an outperformer, the investor should not grudge the relatively small expense ratio charged by the fund house for managing the scheme's corpus.

2.25% is the maximum that Sebi allows a fund house to charge as the annual fund management fee for an equity-oriented fund.

1.85% is the average expense ratio charged by the 230-odd diversified equity mutual fund schemes available in the country today.

Don't invest in a scheme just because it charges a lower annual fund management fee. Actively managed funds have higher expense ratios because they churn their portfolios more often and research their stocks more intensively. Such funds usually give better returns too, which more than makes up for the high expense ratio.

Here's a comparison of the long-term returns from a low-cost fund with those from a high-cost scheme.

LIC MF Growth Fund

Expense ratio: 0.35%

5-yr returns: 3.97%

Birla Sun Life Frontline Equity

Expense ratio: 2.25%

5-yr returns: 15.84%

Annualised returns as on 1 April 2009

Birla Sun Life Frontline fund has justified its higher expense ratio by giving high returns. The LIC MF Growth underperfomed the category average of 13.03% by almost 10 percentage points.

The difference in the expense ratio may not seem too high in the short term, but in the long term, it can add up to an enormous amount. Therefore, a fund with a high annual charge should have the potential to give superior returns that can vindicate the investor's confidence in the scheme.