Over the past few years, mutual funds have become one of the most favoured investment vehicles in India. A mutual fund is a professionally managed investment fund that pools money from many investors and invests in a gamut of securities.
To invest in mutual funds, investors have two alternatives available – direct plans and regular plans. There are just two plans for the same scheme and fund manager also remains the same.
In the year 2012 SEBI had introduced direct plans in the mutual fund. Direct mutual fund plans are those where an investor gets to invest directly with the AMC (Asset Management Company) or the fund house. With direct plans, there is no involvement of third parties like brokers or distributors or banks. Since there are no intermediaries, there is no commission or brokerage involved.
With regular mutual funds, on the other hand, intermediaries like broker, distributors or bank work as the middle man between the investor and the AMC. Brokers, distributors and banks charge commission or brokerage to provide these services.
Saumya Shah, Founder, Tarrakki (incubated by Afthonia Lab) says “In layman’s terms, buying a direct plan is like buying vegetables directly from the farm v/s a regular plan where you are buying the same vegetables from APMC after paying hefty commissions.”
Are Direct Plans better?
According to experts direct plans and regular plans differentiated in 3 facets – Expense Ratio, Returns and NAV.
Expense Ratio – Expense Ratio of a fund measures the per-unit cost for managing the fund. It is calculated by dividing the fund’s total expenses by its assets. Expense ratio incorporates marketing and operational expenses, commission, fund management fees and distribution fees.
Shah, says “Note that the expense ratio of a direct plan is always lower than a regular plan as the AMC is not paying commission to any third-party agent. This lower expense ratio creates a direct impact on returns in the long run as compared to a regular plan.”
Returns – A lower expense ratio leads to higher returns. As no commissions are paid from the investor’s pocket to the bank or to any relationship manager. Hence, the lower expense ratio creates a positive impact on the portfolio and the returns keep compounding.
The same mutual fund can create a hefty difference in an investor’s returns while buying a regular plan v/s a direct plan. Shah says, “The total difference between a direct plan and a regular plan can go up to 25 per cent in 15 years as compounding of profits plays a key role which will have a huge impact on your total corpus.”
NAV (Net Asset Value) – NAV represents the per unit market value of a fund. It is calculated by adding up the market value of all shares and dividing it by the total number of mutual fund units. The commission paid from the investor’s pocket reduces the NAV of the regular plan in comparison to a direct plan. The expense ratio is lower in direct plans, and hence, NAV is higher compared to regular plans.
Experts say these differences are mostly marginal in initial years but in the long run, it becomes substantial. The level at which a direct plan outperforms a regular plan depends upon the investment horizon. Longer the investment horizon, higher the outperformance.
Where to purchase direct plans from?
Industry experts say, there are several misconceptions around buying of direct funds. The most common one is buying directly from the AMC website or application results in buying a direct plan. Shah says, “Investors should keep in mind, in order to avail the direct plan, they need to make sure no ARN number is added to the folio.”
Apart from the AMC, note that direct plans can only be sold by SEBI Registered Investment Advisers. ARN Holders/MF Distributors are not permitted to sell direct plans.