Management Fee vs. Management Expense Ratio: What's the Difference?

The management fee and management expense ratio (MER) are phrases commonly used when discussing mutual funds, exchange-traded funds (ETFs), and other investment funds. While they are related, each refers to different aspects of fund expenses. A management fee is charged by an investment manager for managing the fund's assets, while the MER, typically called the expense ratio, represents the total cost of managing and operating a fund and is given as a percentage of the fund's total assets.

Management fees compensate the fund manager for making investment decisions, conducting research, and performing administrative duties related to the fund. This fee is specifically for asset management services and does not include other expenses related to the fund. Typically, it's calculated as a percentage of the fund's average assets under management (AUM). For example, a fund with a 1% management fee will charge $1,000 annually for every $100,000 of AUM.

The MER or expense ratio represents the total cost of managing and operating a fund and is given as a percentage of the fund's total assets. It includes the management fee and a broad range of expenses. Apart from the management fee, the MER includes administrative, operational, legal, accounting, and marketing costs and fees. In some cases, it also includes performance fees. The expense ratio gives investors a more complete view of the cost of investing in a fund. They can compare the MERs among different funds.

Understanding the distinction between these two fees is important for investors, as it helps to make informed decisions about where to invest based on the cost of different funds.

Management Fee

Mutual and other kinds of funds charge management fees to cover operating costs, such as hiring and retaining investment advisors who manage the funds' investment portfolios and any other management fees not included in the other expense categories. Management fees are commonly called maintenance fees.

A mutual fund incurs many operating fees associated with running a fund other than the costs of trading securities and paying the investment team. These include marketing, legal, auditing, customer service, office supply, filing, and other administrative costs. While these fees are not directly involved with making the investment decisions, they must ensure the mutual fund is run correctly and within the Securities and Exchange Commission's requirements.

The management fee contains all direct expenses incurred in managing the investment, such as hiring the portfolio manager and investment team. The cost of hiring managers is the largest part of the management fee, ranging between 0.5% and 1% of the fund's AUM. Even though this percentage can seem small, the absolute amount could be in the millions of U.S. dollars, for example, if the mutual fund has $1 billion of AUM. Depending on a management's reputation, highly skilled investment advisors can command fees that push a fund's overall expense ratio quite high.

Management Expense Ratio

The costs of trading securities held by the fund are not included in the management fee. Instead, these are transaction costs and are expressed as the trading expense ratio in the prospectus. Together, the operating fees and management fees make up the MER.

A fund’s prospectus provides the expense data for the fund each year. The management fee is significant because the cost of hiring and retaining the investment team is the most expensive part of managing a fund. Therefore, the management fee is frequently cited as the fee to review. However, looking at the MER is a better determinant of how the fund company manages its expenses.

Reviewing these fees in the prospectus isn't always straightforward. Most companies label the management fee as is but can label MER in several ways. Below is an example of how it would typically look:

Example

Fund Company XYZ

• Management fee: 0.39%
• Total annual operating expenses: 1.17%
• Marketing costs: 0.15%

The MER is the sum of these items, 1.71%.

Impact on Returns

If a prospectus says “fund expenses are indirectly borne by investors,” the key word is “indirectly.” While investors do not receive an annual bill for the fund's expenses, they are charged for them by receiving less in returns the fund pays.

However, to make reviewing the prospectus easier, mutual fund companies are required to detail their expenses by producing a figure called "net of expenses," that is, their returns minus all operating costs and fees. By reviewing the return net of expenses, investors can decide whether to invest in the fund after better establishing what the fund yields to investors. As a result, comparing fund companies is easier, and the returns are uniformly presented.

Having a clear understanding of the fees charged by a mutual fund is a significant component of making an informed investment decision. Often, the management fee is used interchangeably with the MER by business publications and financial professionals, but the two are different.

When the MEWR is Lower than the Management Fee

There are rare instances when the MER is lower than the management fee. These circumstances are uncommon, but they occur when the mutual fund company absorbs some costs, such as when a fund is new and has few assets. When a fund is starting out and has few assets, fixed operating costs are proportionately high. Therefore, a fund company may absorb some costs and show the MER at a level it expects it to be when more assets are gathered into the fund.

Another circumstance when a fund absorbs expenses is during a low interest rate environment. When interest rates are low, money market funds see expenses that exceed returns, so the funds often absorb some expenses. Because there can be unusual occurrences from year to year, reviewing the management expense ratio and management fees over several years should give a broader picture of the fund’s expenses investors indirectly bear.

The Bottom Line

Understanding the differences between management fees and expense ratios is crucial for investors. Management fees are specific charges for asset management, while the MER provides a more comprehensive view of the total costs of operating a fund, including the management fee and other operational expenses.

These fees directly impact the returns on investments, with higher fees potentially reducing long-term growth. While lower expense ratios are generally more appealing, balancing these against fund performance, risk management, and your investment objectives is essential. For most individual investors, these fees are nonnegotiable, but they play a key role in fund selection and portfolio management strategies.