Product awareness campaigns by market participants and sustained backing from the regulator would motivate more retail investors to embrace direct plans.
Ever since their introduction on January 1, 2013, direct plans have registered a steady growth in their share of the overall assets of the mutual fund industry. Within just five years of their introduction, their share has grown to 40 percent of the industry’s total AUM (Asset Under Management). Their rising popularity is not just limited to institutional investors. With consistent push from various stakeholders, direct plans already contribute 14 percent of the total AUM held by individual investors. Product awareness campaigns by market participants and sustained backing from the regulator would motivate more retail investors to embrace direct plans. The focus of the communication has to be on how direct plans help in saving investment cost, which then translates into higher returns over the long term.
Here I will brief you about the rationale for introducing direct plans and explain their advantages over their regular counterparts.
Rationale behind introducing direct plans
Mutual funds have various categories and sub-categories catering to different asset classes, investment styles, themes, risk profile, etc. Navigating through these intricacies, doing the paperwork and selecting funds on the basis of one’s goals and expectations is not everyone’s cup of tea. Mutual fund distributors and financial advisors fill this gap by helping investors with the paperwork, fund selection and after-sales services. In lieu of that, these intermediaries receive a commission from the mutual fund houses in the form of upfront and trail commissions. In reality however, the commissions are borne by the investors themselves as the fund houses deduct them, as with other expenses, from the funds’ net assets.
Things started to change 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. However, such DIY (Do-it-Yourself) investors were still forced to pay for the distributor services they never required. Acknowledging such investors’ interest, SEBI directed mutual fund houses to create a separate plan for them from January 1, 2013. These plans 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 their NAVs and expense ratios, other scheme characteristics such as their fund management, investment objectives, asset allocation strategy, investment style and portfolio composition are the same as regular plans. You are also allowed to choose between lumpsum, SIP and STP modes of investment as well as between growth and dividend options.
Why direct plans outscore regular plans
Direct plans score over regular plans on three crucial grounds — expense ratios, NAVs and returns.
Lower expense ratio: This ratio presents a fund’s annual operating expenses as a percentage of its average daily net assets. 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 operating 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 their regular counterparts.
Higher returns: The lower expenses ratio of direct plans have a bearing on their returns. As the savings made in distribution expenses remain invested in your fund, it itself starts generating returns due to the power of compounding. Although, the difference in returns might seem trivial during the initial years, it will become substantial over the long term. For example, the expense ratio of ICICI Prudential Value Discovery Fund’s direct plan is 0.95% lower than its regular plan. Assuming that the SIP of its regular plan fund posts 15% annualised return over the next 25 years and its direct counterpart posts 16%, an investment of Rs 10,000 in the regular and direct plans would grow to Rs 3.29 crore and Rs 3.97 crore respectively. That is a whopping difference of Rs 68.11 lakh of direct plan over its regular counterpart.
Higher NAVs: Direct plans will always have higher NAVs than their regular counterparts due to their higher returns. As a fund’s operating expenses are deducted from its net asset under management, the lower operating ratio of direct funds leads to higher NAVs.
Where to buy direct plans from?
One can purchase direct plans from the mutual fund houses, either online or through their branch offices. However, the process is cumbersome as one has to apply with each fund houses separately, resulting in the duplication of paperwork and the hassle of remembering multiple IDs and passwords. Some independent financial advisors and online mutual fund marketplaces too 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.
Who should invest in direct plans of mutual fund schemes?
According to popular perception, direct plans are not suitable for first time investors or those who lack the finesse of selecting funds on the basis of their financial goals, risk appetite, market conditions, asset allocation strategy, etc. That is a big myth. Digital platforms offering direct plans are equipped enough to provide you with personalised advisory services. They also arm you with their fund recommendations, market insights and various tools and calculators for making sound investment decisions. Hence, even those who need handholding in mutual fund investing can opt for direct plans without paying a rupee for it.The writer is Director- Mutual Funds at Paisabazaar.com