Going ‘direct’ with your mutual fund investments

This is one change in mutual funds that your distributor is not likely to call you up about. On January 1, all mutual fund houses rolled out a new plan under all of their existing products — the Direct Plan.

Targeted at investors who do not make their mutual fund investments through distributors, these plans feature a lower expense ratio than existing plans.

This means that you, as an investor, will get an opportunity to earn a slightly higher return from your mutual fund despite it having the same portfolio.

This change has come about due to a SEBI circular in September 2012, which mandated that all fund houses should have a separate plan for the investors who do not use the services of a distributor.

Fund houses were already barred from charging an upfront commission (entry load) from investors, way back in 2009.

Now, these Direct Plans will not charge annual recurring commissions either. Thus, the Direct Plans will carry lower annual charges and eventually, a different (higher) NAV.

What’s the benefit?

So how much do you stand to gain by investing through a Direct Plan in an equity mutual fund?

The large statutory advertisements put out by mutual funds last week announcing Direct Plans are delightfully vague about this.

They stop with saying that ‘the expense ratio of the direct plan will be lower than that for other plans.’

But talking to industry experts suggests that the Direct Plans could levy expense ratios that are anywhere between 0.30 and 1 percentage point lower than the regular plans.

This is usually the level of trail commission or recurring commission paid to the distributor out of your equity fund’s NAV every year.

This means that an equity fund which currently charges an expense ratio of about 2.7 per cent a year, could trim that to anywhere between 2.4 and 1.7 per cent under its Direct Plan. To get actual details on expense ratios of each fund, you would need to check with the fund house.

Is the benefit big enough to matter? If you plan to hold on to your equity funds for a long period (say, five years or more), it certainly would. To take a simple example, if you invested Rs 1,00,000 in an equity fund’s Direct Plan that generates a 15 per cent return over 10 years, it would grow to Rs 4,04,500 after ten years.

Instead, if you put money in the regular plan, with an expense ratio that was 0.50 percentage points higher, your returns per year would fall to 14.5 per cent. That would leave you with Rs 3,87,300 after 10 years, 4 per cent less than the redemption proceeds from the direct plan.

The difference between direct and other plans could be much narrower in the case of debt and liquid mutual funds, where recurring commissions paid to distributors tend to be quite low.

And remember, this is based on current commissions paid out by mutual funds to distributors. If commissions rise in future (given that SEBI has recently made expense ratios fungible), the differential between Direct Plans and other plans could widen.

How do you get in?

To get the benefits of a Direct Plan, you must not use the services of any distributor, whether an actual agent or a third-party portal (including a bank or online broker) who facilitates your transaction. In fact, only the following three modes of investment will count as direct investments:

Submitting your application at the fund house’s branch office

Registering with the fund house’s own portal and investing through it

Submitting your applications at registrars of fund houses such as CAMS and Karvy.

Investors are permitted to switch from an existing regular plan to a Direct plan, on payment of the specified exit load.

In addition, to be eligible for the Direct Plan, you need to ensure that your application form does not carry any distributor’s ARN code or specifically mentions ‘Direct’ in the relevant box.

But having said this, you should avail of the Direct Plan only if you have the expertise to choose the best funds for your portfolio. The difference between the best and worst performing funds in India can be quite large.

Therefore, it would be quite unwise to avoid an advisor just to cut corners on expenses. This could you cost you quite a bit in terms of sacrifice on long-term returns.

PS While all other fund houses have been busy rolling out Direct plans, Quantum mutual fund has clarified that it will have only one plan under all its schemes.

As the fund house does not use distributors to sell any of its schemes, its expense ratios already do not include any trail or distributor commissions. Therefore, if you would like to invest in the Quantum funds, all their funds are Direct.

Aarati.k@thehindu.co.in

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