Two years back - in January 2013 - when direct plans in mutual funds were introduced with a lot of fanfare by the market regulator Securities and Exchange Board of India (Sebi), there were expectations that retail investors will rush to take advantage of this measure.
But as a chief executive of a fund house admits, there has been a subdued response from the target audience - the retail investor. Instead, investors in direct plans are pre-dominantly institutions in debt funds and high networth individuals in equity plans.
Direct mutual fund (MF) plans offer investors the option of investing directly with a fund house, instead of going through an intermediary like a bank or distributor. (ADVANTAGE DIRECT PLANS)
In these plans, fund houses do not charge distributor commission or trail fees. Due to this, expense ratios are lower by 50-100 basis points as compared to regular plans, leading to higher net asset value (NAV) for direct plans.
Despite the obvious advantages, why have retail investors not gone for them? The cumbersome Know Your Customer (KYC) procedure is one of the main reasons. When Ghaziabad-based Sebi-registered investment advisor (RIA) Jitendra Solanki's clients started switching over to direct plans, it took them four to five days to complete the procedure. They had to update their KYC, create portfolios and do the in-person verification with fund houses. In some cases, it took up to a month, as the client was pressed for time. Yet, Solanki convinced his clients to complete the process and invest in direct plans.
"These are initial hurdles. The higher returns will translate into a significant amount over a 15-20 year period. So, I advise investors to invest in direct plans, even if the investment is as low as Rs 1,000 a month," Solanki says.
The numbers reflect this. Say, you are investing Rs 10,000 through a systematic investment plan (SIP) per month, or Rs 1.2 lakh per year, and planning to use the corpus for a foreign trip after five years. Assuming an annualised rate of return of 10.5 per for a direct plan, the corpus in will grow to Rs 10.36 lakh. On the other hand, the same investment in a regular plan, returning 100 bps less (9.5 per cent) due to higher expenses, will grow to Rs 10.02 lakh. The difference is Rs 34,966, or around $500, a significant amount if you are travelling abroad.
Now, let us assume you are saving the same amount, that is Rs 1.2 lakh per annum, for your child's education 15 years later. The corpus in the direct plan will grow to Rs 49.76 lakh, while the corpus in the regular plan will grow to Rs 45.25 lakh. The difference this time is Rs 4.5 lakh.
KYC is a one-time hurdle, after which investing directly is very easy, agrees Dhirendra Kumar, chief executive officer, Value Research. "All those who can invest by themselves are better off doing so in direct plans because the benefits start from day zero. Ideally, the difference between direct and regular plans should be at least 75 bps. In many cases it is lower because while Sebi mandates regular plans, there is no guideline for the expense ratio of direct plans. So, many fund houses earn higher margins on these," he says.
Growth of direct plans can be aided by streamlining of service procedures like redemption, change of address or bank mandate, initiating a SIP or Systematic Transfer Plan, etc, across fund houses and making more services available online, Kumar adds.
Traditionally, retail investors have preferred to invest through advisors because they lack knowledge on which funds to choose, how much to invest, etc. So, they don't mind paying the higher expenses ratio, as long as they get advice. And, investing through an advisor is operationally easier and investors can get services like consolidated portfolio statements, etc, points out Kaustubh Belapurkar, Director of fund research, Morningstar Investment Adviser India.
"For an informed investor who likes to do research about funds' returns, portfolios, investment philosophy, etc, the direct route is the way to go. On an average, the NAVs of direct plans are higher by 50-90 bps than regular plans, across debt and equity funds. And, with mechanisms like CDSL (Central Depositories Services), from where investors can get consolidated statements on their own, direct plans are definitely more beneficial. But, operationally, it is still a challenge,'' he says.
Regulatory push for direct plans
However, that is being corrected. Recently, the MF Utility platform, a single window and allowing investors to invest across fund houses with only one KYC, started offering direct plans as well. Sebi also directed fund houses to share feeds of direct plans with RIAs. These steps should encourage more retail investors to choose direct plans over regular ones.
"Earlier, I used to ask clients to provide statements of their portfolios, so that I could monitor the investment. Now, I can directly access their portfolios. Other than MF Utility, three more transaction platforms are likely to start operations in 2016. That is why this year we will see more investors switching over to direct plans,'' says Solanki.
Direct plans are as well-managed as regular ones, with the same accounting policies in place, says Gurgaon-based RIA Amit Kukreja's. The only hurdle was the cumbersome procedure to start investing and the paperwork. "For instance, if I recommended a multi-cap fund from 'A' fund house, a large-cap fund from 'B' fund house and a debt fund from 'C' fund house, the client had to submit documents at each of these separately,'' Kukreja says.
This bottleneck can be resolved using platforms like iFast (for distributors) and MF Utility (for investors). Such platforms allow single-window investing across fund houses.
If you are invested in regular plans and want to switch to direct plans, the easiest way is to redeem your money after one year in the case of equity funds or three years in the case of debt funds and invest afresh in direct plans. Otherwise, you could end up paying taxes or exit loads.
"Commissions and new fund launches have drastically come down due to the regulator's push. In the next two to three years, we will see more investors moving to direct plans,'' Kukreja says.
Kumar of Value Research says there is plenty of room for both direct and regular plans to grow. "Still, a lot of people have to be initiated into mutual funds. They are the kind of investors who might feel the need for help from distributors,'' he says.
With the regulator considering allowing the selling of certain kinds of funds through e-commerce portals, investors will have one more investment mode of distribution to choose from. It needs to be seen if this will mean a third kind of NAV, as the expense or commissions in this case could be somewhere between direct and regular plans.
Gurgaon-based Alok Singh, who works in the consumer goods sector, has been investing in mutual funds for eight years. He has investments in eight MFs.
A year before, he switched to direct funds. The KYC process was only a one-time procedure and he had to sign additional documents for a couple of fund houses. "My advisor showed me through calculations that even in the short term, that is two to three years, there is a material benefit from switching to direct plans. So, I was convinced that over a longer period, the benefits would be substantial. There is also a confidence that I am dealing with the fund house directly. It is more direct and transparent,'' he says.
Employee in FMCG sector