What Is a Before Reimbursement Expense Ratio?

The before reimbursement expense ratio is the percentage of total assets a mutual fund must pay to cover operating expenses, measured before managers reimburse any of those fees.

Key Takeaways

  • The before reimbursement expense ratio is the percentage of total assets a mutual fund must pay to cover operating expenses, measured before managers reimburse any of those fees.
  • The reimbursement expense ratio calculation takes place before considering any potential reimbursements to investors from fund managers.
  • The before reimbursement expense ratio tends to go up in lean years, when returns are low but certain fees don’t decrease, and down in good years, when returns are high, and those same fees don’t increase.

Understanding the Before Reimbursement Expense Ratio

The before reimbursement expense ratio, or gross expense ratio, measures the annual operating expenses charged to investors in a mutual fund as a percentage of that fund’s assets.

The calculation takes place before considering any potential reimbursements to investors from fund managers. The expense ratio calculated after deducting reimbursements is the after reimbursement expense ratio, or net expense ratio.

A mutual fund's operating expenses include management fees, transaction fees, 12B-1 fees, and other business costs. Some of these expenses, such as most management fees, are calculated as percentages of net assets. As such, they don’t contribute to shifts in a mutual fund before reimbursement expenses ratio year to year.

Other fees, such as transaction fees, do not represent a predictable percentage of the fund’s total assets in a given year. Those fees produce the yearly shift in before reimbursement expense ratios. Because of those fees, the before reimbursement expense ratio tends to go up in lean years, when returns are low but certain fees don’t decrease, and down in good years, when returns are high and those same fees don’t increase.

If a mutual fund has committed to a capped expense ratio in its prospectus or simply elects to keep it competitively low, it will reimburse investors a portion of operation expenses to boost returns and at the same time produce a lower, after reimbursement expense ratio.

Impact of the Before Reimbursement Expense Ratio

The after reimbursement expense ratio is the one with an immediate impact on investors’ earnings, but the before reimbursement expense ratio also deserves attention.

Most reimbursements are discretionary, meaning that just because managers elected to reimburse some of the mutual fund’s operating expenses this year, investors can't be certain they’ll do the same next year. Investors need to keep an eye on the gross expense ratio to prepare themselves for that scenario.

Further, the before reimbursement expense ratio is a better measure of the actual viability of the company. If they are looking to invest in a mutual fund and they've narrowed it down to two that show similar returns and net expense ratios, comparing gross expense ratios can be an effective way to see which fund is truly healthy and which is on life support.

A nominally small difference between gross and net expense ratios can make a big difference in earnings. A 1.25% gross expense ratio may not look like much because it represents a percentage of total assets. On a mutual fund with a 5% annual return, it would consume 25% of the fund’s profits. Using reimbursements to reach a net expense ratio of 0.75% would keep an additional 10% of the annual return in shareholders' pockets.