Introduction
A capped fund is a type of investment fund which has a predetermined annual limit on the operating expenses of the fund. Mathematically, it is the ratio of a fund's total operating expenses to the average net asset fund. This ratio is also referred to as the cost limitation ratio. The restrictions are generally disclosed by the investment advisor fund when issuing the prospectus.
Understanding Capped Funds
Capped funds have an upper limit on the expenses and holdings affiliated with the funds' management. Mutual fund companies have the right to adjust the expense levels and holdings limits associated with the fund.
Capped Expenses
When determining the limit, i.e. the expense level of a particular fund, mutual fund companies can opt to specify an upper limit for the expense ratio of the fund. This will give investors a fair idea about the upper ceiling of the fees. The capped expense levels are applicable only during a specific period, and revision of the expense levels require approval from the top management.
Though mutual fund houses can revise their capped expenses associated with the funds, investors must be informed of the changes with proper documentation and disclosure. An increase in the capped expense level can inversely affect your returns and vice versa.
Capped Holdings
In some cases, mutual fund houses can also choose to limit the holdings level to prevent a particular holding from having too much leverage on the fund's performance. However, it can be at the sole discretion of the fund company or an investment strategy to balance the fund's performance.
When the holdings levels are capped, the maximum investment level applies to the investment components individually. This will allow fund houses to invest across asset classes. Not only will this ensure that no individual fund components are impacting the fund's performance but also help in diversifying your investments.
