Every mutual fund investor in India has, at some point, compared expense ratios before choosing between two funds. It feels like due diligence. Yet very few investors ever ask a more consequential question: how often does this fund manager buy and sell? The answer — the fund's Portfolio Turnover Ratio — quietly determines a second, largely invisible layer of cost that can dwarf the expense ratio itself over the long run.

UNDERSTANDING THE EXPENSE RATIO

The Total Expense Ratio (TER) is the annual fee an Asset Management Company charges for running a mutual fund scheme — covering fund management, administration, distribution commissions, marketing and other operating expenses. It is expressed as a percentage of the scheme's daily average net assets and is deducted directly from the Net Asset Value (NAV), which means investors never see a separate bill; the cost is absorbed silently into returns.

In India, the Securities and Exchange Board of India (SEBI) regulates the maximum TER an AMC can charge, on a reducing slab basis tied to the scheme's Assets Under Management (AUM). Larger funds are required to charge progressively lower percentages, on the logic that economies of scale should be passed on to investors.

Illustrative slabs based on SEBI's TER regulations for open-ended equity schemes (regular plans); direct plans typically run 0.5%–1.0% lower since they exclude distributor commission. Debt schemes carry a lower cap, generally topping out near 2.00%.

This is precisely why direct plans — where an investor bypasses a distributor and invests straight through the AMC — consistently outperform regular plans of the same scheme by roughly the commission saved, typically 0.5% to 1% a year. Over a 20-year SIP, that difference alone can be worth several lakhs of rupees, purely from an unchanged investment strategy.

A Quick Compounding Illustration

Consider a ₹15,000 monthly SIP for 25 years, assuming a gross annual return of 12% before costs. A fund with a 1% expense ratio versus one with a 2% expense ratio does not merely cost "1% more" — because costs compound too. The 1% fund could accumulate a corpus close to ₹2.83 crore, while the 2% fund, growing at a net 10% instead of 11%, lands closer to ₹2.29 crore. That single percentage point, compounded over a working lifetime, is the difference of roughly ₹54 lakh — enough to change a retirement outcome.

UNDERSTANDING PORTFOLIO TURNOVER RATIO

Portfolio Turnover Ratio (PTR) measures how frequently a fund manager churns the portfolio — buying new stocks and exiting existing ones — over a year. It is calculated as the lower of total purchases or total sales during the year, divided by the average AUM of the scheme, expressed as a percentage.

A PTR of 20% implies the manager effectively replaces about one-fifth of the portfolio annually — consistent with a long-term, conviction-driven, low-activity style. A PTR of 150% implies the entire portfolio is, in effect, replaced one-and-a-half times a year — a highly active, tactical, momentum-driven style.

Unlike the expense ratio, PTR is not capped by any regulator and is disclosed only in fund factsheets, typically in fine print, without much explanation of what it costs the investor. This is exactly why it functions as a hidden cost — most retail investors in India have never looked at this number before selecting a fund, even though it materially affects returns through four separate channels.

None of these four costs appear anywhere near the expense ratio disclosure. They are absorbed inside the NAV before it is even published, which is precisely why two funds with an identical 1.5% TER can deliver meaningfully different net returns if one has a PTR of 25% and the other has a PTR of 120%.

EXPENSE RATIO VS PORTFOLIO TURNOVER — SIDE BY SIDE

AN INDIAN CASE STUDY: TWO FUNDS, ONE DECISION

To see how these two costs combine in practice, consider two hypothetical Indian equity funds — Fund A, a low-churn, large-cap-oriented fund, and Fund B, an actively traded multi-cap fund. Both are assumed to generate an identical 12% gross return before costs, so that the entire difference in outcome is attributable to cost structure alone.

*Hidden trading cost is a simplified estimate combining brokerage, Securities Transaction Tax (STT), impact cost and bid-ask spread, applied proportionally to the turnover ratio. Actual figures vary by fund, market cap segment and trading liquidity. Figures are illustrative, not a recommendation for or projection of any specific scheme.

The lesson is not that active management is inherently bad — many skilled Indian fund managers have delivered genuine alpha even after high turnover. The lesson is that turnover-driven cost must be evaluated alongside performance, not ignored simply because it does not appear on the same disclosure page as the expense ratio.

THE TAX ANGLE MOST INVESTORS MISS

India's capital gains tax regime adds a further, often overlooked, layer to the turnover story. Since April 2018, equity mutual funds have attracted Long-Term Capital Gains (LTCG) tax on gains above ₹1.25 lakh in a financial year at 12.5%, while Short-Term Capital Gains (STCG), for units held under 12 months, are taxed at 20% (rates as revised in recent Union Budgets).

While this tax primarily applies at the investor level when redeeming units, high internal churn inside the fund forces the manager to book gains and losses more frequently, which can affect the fund's tax efficiency and its ability to carry forward losses to offset future gains. A low-turnover fund, by contrast, lets unrealised gains compound quietly inside the portfolio for years — a benefit informally described as tax deferral through inactivity.

A PRACTICAL CHECKLIST BEFORE YOU INVEST

▸  Look up both the expense ratio and the portfolio turnover ratio in the fund's latest factsheet — both are published monthly by every Indian AMC.

▸  Prefer direct plans over regular plans wherever you are comfortable managing the investment yourself; the commission saved is a guaranteed, risk-free improvement in returns.

▸  Treat a very high PTR (above roughly 100%) as a prompt to ask what strategy justifies the additional trading cost — momentum and tactical funds may justify it; plain-vanilla diversified equity funds usually should not need it.

▸  Compare category averages, not just one fund in isolation — large-cap and index funds typically run PTR under 30%, while thematic, sectoral and small-cap tactical funds often run well above 80–100%.

▸  Track your fund's rolling 3-year and 5-year net-of-cost returns rather than trailing 1-year returns, since cost drag from turnover compounds and becomes more visible over longer holding periods.

▸  Remember that low turnover and low cost do not automatically mean better returns — they mean a lower hurdle the fund manager has to cross to add value for you.

CONCLUSION

Expense ratio is the cost every Indian investor has been trained to check. Portfolio turnover is the cost almost nobody checks — and that asymmetry is exactly why it deserves more attention, not less. A fund that looks cheap on TER can quietly erode returns through trading costs and tax drag, while a fund that looks slightly more expensive on paper may in fact be the more efficient long-term compounding vehicle once total cost of ownership is considered.

The next time you shortlist a mutual fund, don't stop at the expense ratio on page one of the factsheet. Turn to the portfolio turnover figure a few pages later — because the real cost of investing is rarely just what you're told about; it's what you have to go looking for.

This article is for general educational purposes and does not constitute investment advice. Fund names, figures and scenarios used are illustrative. Investors should consult a SEBI-registered investment adviser and read scheme documents carefully before investing.