Synopsis : Lower expense ratios don’t automatically guarantee higher returns in active equity mutual funds, says Niranjan Avasthi of Edelweiss MF. Data shows there’s no consistent link between lower costs and better performance, challenging a popular investor belief.
The belief that lower expense ratios in equity mutual funds directly lead to higher returns has been challenged by Niranjan Avasthi, Senior Vice President at Edelweiss Mutual Funds, who highlights that the reality in active equity funds is far more nuanced. While lower costs undeniably benefit investors in passive funds where tracking the index at minimal cost is the primary goal, the same logic does not translate seamlessly to actively managed funds, which depend heavily on the fund manager’s stock-picking ability to generate alpha.
Avasthi’s analysis of all active equity funds over the past three years shows no clear correlation between lower expense ratios and higher returns across categories. In many cases, funds with mid-range or even higher expenses delivered superior performance, defying the expectation that lower costs automatically translate into higher gains. For instance, large-cap funds with expense ratios between 2.00–2.25% posted an average three-year return of 20.27%, outperforming some funds with lower costs. Similarly, flexicap funds in the same expense range delivered 24.21% returns, higher than the 21.28% returns from funds with expenses below 1.75%.
The pattern persisted in midcap and smallcap categories, where higher expense ratio funds often recorded strong returns, demonstrating that fund management quality and market dynamics play a far more significant role than costs alone in determining performance outcomes. While acknowledging that expense ratios remain crucial as they directly impact investor returns, particularly in volatile markets and over long-term SIP investments, Avasthi emphasised that investors should not consider expense ratios in isolation when selecting active equity funds.
He noted that lower expenses are critical in index-based investments like ETFs and index funds, where returns closely mirror benchmarks, making cost a direct determinant of net returns. However, in actively managed funds, the premium paid for management expertise may be justified if the fund consistently beats its benchmark, especially in uncertain economic conditions where informed stock selection becomes crucial.
As investor awareness grows and SEBI regulations tighten, fund managers are under increasing pressure to justify higher costs with tangible outperformance. Direct plans, known for their lower expense ratios, continue to attract informed investors seeking cost-efficient growth, but for those looking into active funds, Avasthi’s insights offer a clear takeaway: don’t chase low expenses blindly. Instead, assess the fund’s strategy, past performance, consistency, and the quality of its management before making an investment decision.
In a market environment where myths often drive investment choices, Avasthi’s data-backed analysis serves as a timely reminder that while fees matter, they are just one piece of a much larger puzzle when it comes to building wealth through active equity mutual funds.
Disclaimer : This article is for informational purposes only and does not constitute investment advice. Please consult a qualified financial advisor before making any investment decisions.
