Direct Plan in mutual funds were introduced on 1st January 2013 & since then within five years their share has grown to 40% of the industry’s total AUM. With consistent push from various stakeholders, direct plans contribute 14% of the total AUM held by individual investors. Product awareness campaigns by various market participants have consistently increased retail participation in direct funds.
Mutual fund distributors/brokers and financial advisors help investors with the paperwork, fund selection and after-sales services. In lieu of that, they receive a commission from the mutual fund houses in the form of upfront and trail commissions. In reality the commissions are borne by the investors as the fund houses deduct them, in addition to other expenses, from the funds’ net assets. Thus the expense ratio of regular funds are always higher.
With increased financial awareness empowering many to make their own investment decisions and technological advancements allow them to buy, sell and avail other services online there was a need to create a separate plan without commission. Thus SEBI directed mutual fund houses to create a separate plan which were termed as ‘direct plans’ as investors could buy them directly from the fund houses without the involvement of financial intermediaries or their expenses associated with them. Other than NAVs and expense ratios, other scheme characteristics such as fund management, investment objectives, asset allocation strategy, investment style and portfolio composition are the same as regular plans.
Direct plans score over regular plans on higher returns. We look at aspects like expense ratios, NAVs and returns. They are all related to one another as a lower expense ratio leads to higher returns & NAV.
Operating expenses include distributor’s commission along with administration, management, advertising expenses, etc. As fund houses do not incur distribution cost in direct plans, the expenses of direct plans are lower than the regular plans, which translate into lower expense ratio. The expense ratio of direct plans is usually ~1% lower than that of corresponding regular plan.
The lower expenses ratio of direct plans leads to higher returns as the savings made in distribution expenses remain invested and compound over a period of time. Although, the difference in returns may look trivial during the initial years, it becomes substantial over the long term. For example if expense ratio of direct plan is 1% lower than its regular plan, assuming that the SIP of its regular plan fund gives 15% annualized return over the next 25 years and its direct plan gives 16%, SIP investment of Rs.5000 in the regular and direct plans would grow to Rs.1.64 cr and Rs.1.99 cr respectively.
Direct plans have higher NAVs than corresponding regular plan due to higher returns. As a fund’s operating expenses are deducted from its AUM, the lower operating expense of direct funds leads to higher NAVs.
One can purchase direct plans from the mutual fund houses, either online or through their branch offices. Some independent financial advisors and online mutual fund marketplaces also offer direct plans but only in lieu of an advisory fee. This fee is directly paid by the investor and not routed through the fund houses.
Sabyasachi Paul has been associated with equity research and advisory on equity markets in India for over 9 years & currently heads the equity research desk of Eastern Financiers Ltd, Kolkata. He also manages a portfolio on the online platform Kristal. Find link to the strategy named ‘The Tortoise’