Mutual funds Direct plans: Things to know

Courting retail investors is an ongoing endeavour in India. For a country that has been traditionally drawn to gold and real estate as sources of investment, the government has been persistently introducing measures to encourage them to consider other avenues of saving. So when SEBI (Securities Exchange Board of India) mandated the offering of direct plans for mutual fund investors, it seemed to be in line with the same ideology.

Direct Plans 101

Direct plans in mutual funds, as opposed to regular plans, involve investors and mutual fund houses working together without the involvement of a distributor or an advisor. SEBI requires fund houses to provide additional disclosures in consolidated account statements (CAS) – first, the commission earned by the distributor on the mutual funds in question and second, the expense ratios of direct as well as regular plans for the mutual funds in question. The logic behind this move was primarily to reduce the total Expense Ratio (ER) as well as increase transparency in transactions for the investors.

When an investor notes the information provided above, he or she might be naturally inclined to conclude that direct plans are cheaper than regular plans. This realization automatically leads to an exodus of investors from regular plans towards direct plans.

Demystifying the expense ratio (ER)

Expense ratio is essentially the cost of managing a mutual fund on a per unit basis. A fund’s total assets divided by the assets under management would provide the expense ratio of said fund. Daily Net Asset Values (NAV) of funds are reported after deducting the expenses.

Impact on Investors

Investors need to be wary of expense ratios as they can have a significant impact on returns. A comparative study of NAVs of direct versus regular plans of HDFC Top 200 was conducted for the period between Jan 2013 to March 2013. ER on direct plans was 1.19% whereas regular plans had an ER of 1.78%. At the end of the mentioned period, the NAV of the direct plan was 0.13% higher than the NAV of the regular plan.

Keeping the same plan in mind, if one invested an approximate SIP of Rs 5000 per month at a return of 10%, the difference in corpus would be significant over longer periods. After 10 years, the direct plan corpus would be Rs 1,055,096 while the regular plan would have a corpus of Rs 940,969. In twenty years the amounts become Rs 3,482,980 and Rs 2,980,366 respectively whereas after thirty years they amount to Rs 9,069,788 and Rs 7,400,422 respectively.

Impact on distributors

Ever since SEBI has mandated the disclosure of commissions earned by distributors, investors have been migrating to direct plans thereby affecting the income of distributors. In FY15, distributors were paid Rs 4744.57 crore whereas in FY16 the total commissions paid out were Rs 3647.63 crore. A clear drop of 23% is evident from the numbers.

In terms of top performers, the leader of FY15 HDFC Bank was replaced by NJ IndiaInvest Pvt Ltd earning a total distribution commission of Rs 326.10 crore.

Target audience

The ideal target audiences for direct plans are investors who have a basic know-how of how mutual funds work as well as fair knowledge of reliable players. In case of existing investors, the KYC paperwork is already completed hence the formalities are minimal. With first-time investors, KYC information needs to be recorded with the help of forms and instructions from the fund houses.

Also, corporate investors benefit more from going direct rather than investors whose portfolios are small.

Although designed with laypersons in mind, direct plans are better considered as calculated risks rather than impulsive ones.

Benefits

Direct plans benefit retail investors in more ways than one.

Transparency: With the disclosure of commissions earned by distributors, investors gain a crystal clear idea of how their money is utilized.

Increase in returns: A short-term view of gains when comparing direct and regular plans would probably not provide numbers that impress. However, when one abandons the myopic view for a long-term one, the profits become significantly higher. With equity funds, direct plans can bring up to 0.5% increase in returns while debt funds can enjoy approximately 0.2%.

Lower costs: The absence of distributor commissions means lowered expense ratio and lower costs for investors.

No qualifications required: When it comes to mutual funds, distributors and advisors are required to have adequate qualifications and experience. However, this is not the case with direct plans – investors can independently make purchase decisions without the need for specific qualifications.

Ease of access

To further the simplification of access, SEBI has decided to let major e-commerce players such as Flipkart and Amazon sell mutual funds online. Care is being taken to ensure that the platforms that are allowed to sell funds this way have a specific volume of sales, reasonable net worth, customer base and brand popularity. SEBI hopes that credibility established in this manner will encourage investors to make the investment online.

Apart from seamless transactions, direct plans online are also expected to include minimal commission payable to the platforms. This means that the investor doesn’t have to spend as much as expected with regular plans. These platforms are also expected to alert investors in case they choose products that are not suitable for their requirements.

Final word

With advisors and distributors’ involvement being minimized, investors might find themselves taking on the added responsibilities of careful tracking, decision-making and paperwork. Even in case of online mutual funds products, the degree of intuitive matching of investor requirements to appropriate mutual funds will probably take a while before it evolves to completely replace expert professional advice.

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