Back in 2009, when SEBI banned the concept of AMCs charging entry loads, it helped mutual fund investors save substantially on costs. SEBI gave an option to investors that they could go directly to the AMC and invest as a direct customer or they could go through a broker. The real difference only became evident from January 2013 when the mutual fund AMCs were required to disclose separate NAVs for regular schemes and for direct schemes. Since the direct schemes had lower loading in the absence of marketing and servicing costs, they had a lower Total Expense Ratio (TER) and hence their NAV was higher compared to a Regular Plan. That is why if you compare the NAV of a direct plan and the regular plan of the same fund, you will find the NAV of the direct fund higher due to lower costs.
Let us understand how to invest in direct plans of mutual funds. Let us also focus on the benefits of the direct plan mutual fund and the risks.
Let us take the case of Franklin India Equity Fund
Data Source: Value Research
We have considered the CAGR returns of the Direct Plan and the Regular Plan of the Franklin India Equity Advantage Fund (G). We have considered the period from Jan-2013 since that is when the Direct Plans were assigned a separate NAV. What we find is a difference of nearly 90 basis points in the CAGR returns. The Direct Plan has obviously performed better compared to the regular plan due to lower cost ratio.
Direct Plans are not cost-free
There is a popular misconception that Direct Plans do not entail any costs. That is not the case. In case of Direct Plans, the costs are partially reduced since the marketing costs do not exist as the investors directly approach the fund AMCs. Here are 4 things you must know:
Since there is no entry load allowed now, the fund charges the regular investors for the market and outreach expenses. That is normally around 1% of the AUM. However, the entire 1% is not passed on as benefit to the Direct Plan holders. They get a benefit of around 0.60% after common allocations.
Exit loads will continue to apply for Direct Plans and the Regular Plans since it is based on your holding period. That means, if you do not honour the minimum holding period, then you are charged exit load even if you are invested in a direct plan.
The total expense ratio (TER) of the Direct Plan is around 60-70 basis points lower compared to the Regular Plan. This lower cost translates into a higher NAV and therefore higher returns for the Direct Plan. The illustration of Franklin Templeton gives a rough idea of the advantage that you can get in a Direct Plan over a 5 year period.
The TER of the fund consists of a variety of costs like marketing & distribution costs, registry costs, audit costs, custodial charges, administrative charges, fund management costs etc. Other than the market & distribution costs, the other costs get defrayed proportionately to the Direct Plan holders also.
When to choose Mutual Fund Direct Plans
There has been a surge of direct plan investments in the last few years driven by the lower costs. Who should opt for a Direct Plan and who should go for a regular plan. There are no hard and fast rules but here are five guidelines on whether you need to opt for a Direct Plan or a Regular Plan.
If you are looking at a portfolio of mutual fund schemes to meet specific goals, it is always better that you opt for a regular plan as you will get the benefits of expert advice on how to good about it.
A good mutual fund may not be good for you. For example, a particular debt fund may be giving above average returns but the risk profile may not suit you. In that case, it is better you take the services of an advisor who can customise the fund package for you.
What is your level of understanding of mutual funds? It is a lot more complicated and multi-faceted than you can imagine. Unless you really have the expertise to undertake such detailed analysis on your own, it is always better that you opt for a regular plan and take the services of an expert advisor.
Direct investing can be specifically risky in case of asset classes like mid-cap funds, small-cap funds, sector funds and thematic funds. In such cases, it is always advisable to seek expert advice before committing money to the fund.
There is the risk that in the era of free flow of information you are deluged with information. You need to separate the wheat from the chaff. You have new concepts like AI, robo advisory, machine learning, direct mutual fund platform etc. Unless you are on top of all these trends, it is better to take the help of an advisor.