Direct route to higher returns

It’s been almost a year since mutual fund houses began peddling the ‘direct’ plan. If you haven’t invested in funds through this route yet, do give it a thought. This is because direct plans, by virtue of their lower expenses, have delivered higher returns than the regular plans under the same scheme.

Why the benefit Let’s first get back to the basics to gain some perspective. A direct plan is when you invest in a scheme directly with the mutual fund house, instead of going through a distributor, or any third-party agent.

But you could have applied directly to mutual funds earlier, too. What’s changed now? Well, from January 2013, fund houses have been offering separate schemes under the direct and regular plan (where you buy the fund via a distributor), according to the mandate set out by the Securities and Exchange Board of India. Mutual fund houses thus declare two NAVs — one for the regular plan and the other for the direct one.

Buying a direct plan allows you to receive the benefit from the lower expenses inherent in these plans, which wasn’t there earlier. The expense ratio for a direct plan is lower than that of a regular plan.

Aside from the fee paid to the professionals and other legal or audit expenses, the total expense of a fund also entails marketing and distribution expenses. When you apply directly to the fund, the distributor commission is circumvented. The expenses the fund incurs, therefore, drop to the extent of the distribution cost.

The net asset value (NAV) of a scheme is thus also higher in direct plans than in regular plans. This doesn’t mean that the fund is more ‘expensive’; it means that the value of your investment is more.

Until the direct plan was offered, the lower expense benefit was not passed on to such investors. The expense ratio, which is the cost of managing a fund, remained the same whether or not you invested through a distributor.

“The resultant savings of expenses ranges between 0.05 and 0.1 per cent in case of liquid funds, 0.4 and 0.5 per cent in other debt schemes and up to 1 per cent in the case of equity funds,” says Rajmohan Krishnan, Co-founder and Managing Director, Entrust.

The lower expense ratio translates into higher returns. Over a period of time, the extra returns add up due to the compounding effect.

Investment procedure To invest in direct plans, you need to specify that it is ‘Direct’ in the broker code column. If you’re an existing investor and want to switch to a direct plan, there is no automatic switchover to it.

You will need to switch your units as done in any other case. Note that this may result in tax incidence, if applicable. Also, in case you switch out from an existing regular plan to a direct plan, where you mentioned the broker code (in the regular plan), exit loads applicable will be charged. .

Tracking performance With direct plans only commencing in January this year, data on performance will be limited. So to analyse how the fund has performed, look to the regular plans under each of these schemes, which will have a longer track record of performance. The mandate and the portfolio of investments is the same for both funds.

“If the underlying scheme is doing well, automatically the direct plan would generate better returns. In fact, the best fund would be the one which has top quartile performance with the lowest direct plan expense ratio,” says Krishnan.

The rise in direct plans since January has been due to institutional investors (which are the main players), and some HNIs shifting to such less expensive plans. This is because these are ideally the more informed investors who can decide based on their own assessment.

Opt for the direct route if you are sure about which funds to invest in. Be sure also to assess the track record of the fund manager, consistency in performance and pedigree of the AMC to select such schemes.

> radhika.merwin@thehindu.co.in

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