Cheaper way to invest

Direct plans work for educated investors or ones who will concentrate on large-cap funds or ETFs

Market regulator Securities and Exchange Board of India (Sebi) is constantly striving to reduce investment costs for retail investors. Under former chairman Chandrashekhar Bhave, it allowed investors to visit an asset management company's (AMC) office and make the investments there. The saving: 2.25 per cent of the distributor's fees in equity funds. Then, mutual fund schemes were listed at the stock exchanges. The most controversial decision was, of course, the entry load ban.

The present Chairman U K Sinha has carried forward that tradition by asking mutual fund houses to provide a direct plan option for all their schemes. Investors who are willing to go directly and invest can earn 50 basis points more annually.

Mutual funds charge an expense fee of 2-2.5 per cent. Smaller schemes with AUMs of, say, Rs 500-600 crore, can charge around 2.50 per cent. Larger schemes managing Rs 2,500-3,000 crore charge an expense ratio of around two per cent.

In this expense fee, a number of costs are included, such as, investment management fees (around 1-1.25 per cent), registration and transfer charges, custodian charges, investor communication and trustee fees, among others, says Hemant Rustagi, chief executive officer, WiseInvest Advisors. These would add up to around two per cent. So, investors benefit by 50-75 basis points. The savings in debt funds will be lower at 10 to 20 basis points. However, it has now been over three months since launch on January 1 but direct plans have not attracted too many investors.

While it is too soon to judge the success or failure of the option because retail investors have consistently been pulling out money for over two-three years due to uncertainty in the stock markets, the past options - direct investment at the AMC's office and listing at the stock exchanges - did not yield great results either. As a recent report by rating agency Crisil points out, mostly institutional investors have used this window, and for obvious reasons - given the substantial amount they invest in debt, even a 10-20 basis points benefit would improve returns substantially.

But retail investors, who aren't market experts and wish to use this opportunity, need to play it safe. That is, go for simple options, like large-cap funds with good historical record of over 10 years. Good performance over longer periods implies that the scheme has done well in both bull and bear cycles. Otherwise opt for exchange-traded funds, especially ones which mirror the S&P Sensex or Nifty. Anyway, the latter schemes are cheaper and there is a higher element of safety as these are expected to perform in line with the underlying indices.

If you are an existing investor, take into account the securities transaction tax, exit load and short-term capital gains tax before moving to a direct plan. Exit load and short-term capital gains tax will be applicable for investments less than a year old. For existing investors wishing to shift to direct plans, experts suggest, starting a new direct investment and once the present one is over a year old (won't attract tax or load), move these to the direct plan as well.