A few years back, SEBI directed mutual fund houses/Asset management companies (AMCs) to offer a separate investment plan to investors who were investing directly with the fund house. Subsequently, fund houses started offering two plans for every mutual fund scheme. The two plans are regular plan and direct plan.
Regular and direct plans
Regular plans are the norm. Most of us go to the regular distributors or use various online platforms to invest in mutual funds. These distributors or online channel partners typically do not charge anything from the customers. However, asset management companies (AMCs) or mutual fund houses pay these distributors/online channels upfront and trailing commission to drive investor funds to them. Though even AMC does not charge directly to the investors, this commission paid gets reflected in the higher expense ratio. In simple terms, expense ratio is a measure of cost that you pay to the fund house for managing your money. Expense ratio includes everything from fund management fees, operational and marketing expenses to distribution expenses.
Under direct plans, you approach the fund house/AMC directly rather than going through any intermediary. Since there is no distributor/intermediary involved, distributor commissions are avoided under direct plans. Keeping everything else same, a lower expense ratio means lower costs and hence better returns. Since everything else (portfolio, stock holdings etc) is exactly same in direct plans and regular plans, direct plans offer better returns than regular plans.
NAV for the regular and direct plans are different
Though the portfolio for the regular and direct plans is same, the NAV for the direct plan is higher than regular plan due to lower expense ratio. For example, NAV for Axis Long Term Equity fund (Growth) is Rs 30.75 for direct plan and Rs 29.85 for regular plan. Do not make the mistake of believing that the regular plan is cheaper (because of lower NAV). Both had started at the same level post SEBI directive. Owing to the difference in cost structures, this gap will only widen over a period of time.
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What is the impact on returns?
We have already established that the expense ratio for direct plans is lower and thus direct plans will give better returns than regular plans. However, we have still not assessed the quantum of impact on your absolute returns over the long term. To assess the same, we consider top 20 equity funds (based on 5-year returns) and take the average of difference of expense ratio between direct and regular plans. All the data has been compiled from information available on ValueResearch. Funds for which expense ratio for direct plans was not available on ValueResearch website have been excluded from the exercise. The average expense ratio for regular plans was 2.58% p.a. while for the direct plans it was 1.59% p.a. Hence, the difference stands at 0.99% p.a. You can expect similar difference in returns too.
Please note that the gap between the regular and direct plans is not same across MF schemes. For example, smaller fund houses may have to shell out more in terms of distributor commissions to attract investor funds. The difference of 0.99% p.a. is merely an indicative figure and may be different for your scheme. Even in our consideration set, the difference in expense ratio varied from 0.51% p.a. to 2.03% p.a. Considering this difference in expense ratio and concomitant returns in the two plans, let’s see the impact on absolute returns with the help of an example.
We have assumed a SIP of Rs 10,000 per month for two tenors (10 and 15 years) and two levels of returns (8% and 12%). If return mentioned is 12%, we have taken return for regular plan at 12% and for direct plan at 12.99%.
|SIP Amount||Return||Tenure||Amount at the end of SIP Tenor||Difference|
|(per month)||(% p.a.)||(Years)||Regular Plan||Direct Plan|
|Rs 10,000||8.00%||10||18,29,460||19,34,049||Rs. 1,04,589|
|Rs 10,000||12.00%||10||23,00,387||24,38,919||Rs. 1,38,533|
|Rs 10,000||8.00%||15||34,60,382||37,80,645||Rs. 3,20,263|
|Rs 10,000||12.00%||15||49,95,802||54,91,963||Rs. 4,96,161|
You can see what a mere difference of 0.99% p.a. can cause in the long term. That is the power of compounding. The difference increases with the SIP tenor and is too high to ignore. The case for investing in direct plans of MF schemes is much stronger now.
How do I invest in direct plans?
You need to visit the nearest office of the AMC once and submit KYC documents. During the visit, you can also register for online transactions and do all your subsequent transactions including purchase/redemption, registration and cancellation of SIPs online (even in other funds of the same AMC). A lot of people make the mistake of approaching the parent bank (e.g. Axis Bank for Axis MF schemes) for investing in direct plans of mutual funds. Please note it does not work that way. Banks act as distributors for the fund houses. Hence, the banks will always get you invested in a regular plan. If you want to invest in direct plan, go to respective AMC’s nearest office.
Can I switch my existing investments from regular plan to direct plan?
Yes, you can. You can submit a request to the concerned mutual fund house for the switch. However, a switch from regular plan to direct plan will be considered redemption from regular plan and a fresh investment into direct plan. Therefore, capital gains tax and exit load implications may arise on sale of units from regular plan. For example, if you have held an investment in regular plan of an equity fund for only six months and decide to switch to direct plan, you will be liable to pay short-term capital gains tax (15% of gains, if any) and applicable exit load.
Moreover, units in direct plans will be subject to fresh lock-in periods, if any. For instance, if you have been invested in regular plan of an ELSS (Equity-linked savings scheme or tax-saving mutual funds) for five years and decide to switch from regular plan to direct plan, units purchased in direct plan will be subject to a fresh lock-in period of 3 years. Hence, you need to consider these aspects before you decide to make the switch.
On the other hand, if you have held units in equity MF for over an year, there shall be no capital gains tax and exit load (exit load is typically nil after one year). Hence, you can easily make the switch and save on distribution expenses.
What are the operational drawbacks?
For every new AMC you want to invest with, you will have to visit the nearest office of AMC once to complete formalities. For example, you have never invested in HDFC mutual funds and want to invest in direct plans of the fund house, you will have to visit their nearest office once. This is a major deterrent for investors who wish invest in direct plans of mutual fund schemes.
How does MF Utility help overcome this drawback?
MF Utility platform is an initiative by Association of Mutual Funds in India (AMFI). MF Utility is owned by MF Utility India Pvt. Limited, which in turn is owned by participating mutual fund houses. Through MF Utility, you can invest in direct plans of mutual funds through a single interface i.e. you don’t have to approach each mutual fund house separately.
You just need to visit the nearest Point of service (PoS) of MF Utility and submit CAN Registration form (along with required documents). CAN stands for Common Account Number. CAN is an industry level folio number. Your investments with any MF house can be identified using CAN. Currently, MF Utility platform is available to retail investors in offline mode i.e. you will need to submit physical transaction forms at the nearest MFU PoS. The online channel is expected to be launched for retail investors by the end of the year. Like other investment portals, MF Utility platform allows purchase/redemption of units and registration/cancellation of systematic investments plans. MF Utility also provides consolidated account statements for your investments across the industry. If you do not want to visit offices of various AMCs, MF Utility can be a good option for investments in direct plans.
Direct plans are best suited for do-it-yourself investors who can research mutual funds on their own and then save costs by investing in direct plans of mutual fund schemes. If you need any assistance in selecting funds, you may be better off going through the regular channel of distributors but you need to aware of the inherent conflict of interest. Distributors get commissions on every purchase you make through them. Alternatively, you can seek help from fee-only financial planners/SEBI registered investment advisers. Fee-only financial planners do not accept any sales commission and charge a small fee for their services. Savings made through investments in direct plans shall more than make up for the fees paid.
A lot of people select mutual funds on their own and invest in regular plans through various online investment portals. If you fall in the same category, switching to direct plans can be a great boon for you. You can make fresh investments in direct plans. For the existing investments, do consider capital gains taxation, exit loads and lock-in restrictions before making the switch to direct plans.
Deepesh is a SEBI registered investment adviser and Founder, PersonalFinancePlan.in