Every other person says you must go for direct plans because you don’t have to pay any commission. This might not be true. One needs to dig deeper.
The hype over direct plans of Mutual Funds has been around for the past 5 years. ‘Experts’ have been going around saying direct plans will fetch you more returns. Now, before we go into why these ‘experts’ may not be right, it’s important to understand what direct plans are.
The history
Way back in September 2012, the Securities Exchange Board of India (SEBI) came out with some customer-centric changes to Mutual Funds. Launching of direct plans was one of them. SEBI insisted that every Mutual Fund house have direct plans for their funds. This was to reduce the cost of owning a Mutual Fund.
What is it?
Direct plans allow you, the investor, to invest directly with a Mutual Fund house. There are no intermediaries involved. To invest in a regular plan, you take the help of a distributor or advisor. They get a commission for this.
Mutual Fund houses pay upfront fees to agents and distributors for their services. This is taken out of the expense ratio of the funds. Usually, the expense ratio of direct plans are lower than that of regular plans because there are no commissions to be paid to agents in case of regular plans.
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You must understand that this results in different NAVs for both the plans. However, the scheme’s portfolio will be the same for direct and regular plans. Also, scheme features such as investment strategy, investment objective, exit loads and other risk factors will be the same. The expense ratio is the difference. The difference could be as high as 1%. This is the reason why many say direct plans can give better returns.
However, there are few things you need to analyse to understand whether you are really benefitting from a direct plan.
Why regular plans?
With regular plans, you get investment advice. The agent/distributor will help you choose the right funds and, in the case of underperformance, will help you switch funds. The difference between returns of a good fund and bad fund can be as high as 20%. Distributors/ agents also help review your portfolio every year. This will ensure that your portfolio is on track. In case of direct plans, you need to do all the research and reviews.
So, direct plans are for savvy investors. Even if you are a savvy investor, direct plans may not give you that edge that you want.
The truth
It has been recently discovered that Mutual Fund houses have been using money from expense ratio of direct plans to pay agents’ commissions. How can they do this? Whatever money that is collected by fund houses is income for them. They pool the income and pay distributor commissions from the total amount. Most times, the commissions might be much higher than the income they get from regular plans. So, they would have to use income from direct plans to pay commissions. There’s nothing wrong here because fund houses are institutions and need to make profits. So, it can’t be said that the expense ratio money from direct plans is not used to pay distributor/agent commission.
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Another development is that fund houses have started increasing the expense ratio of direct plans after SEBI put a cap on expense ratios of funds. So, Mutual Fund houses which were charging higher amount than the limit had to cut down on expense ratios of regular plans. However, with expenses remaining the same, fund houses have to get income. So, expense ratios of direct plans were increased.
Looking at all this, SEBI has now said that fund houses should charge commission only for regular plans and shouldn’t use direct plans’ income for this, even indirectly. So, even if the expense ratios of direct plans are not increased now, they might be hiked later.
At the end of the day, the only things you, as an investor, should look at are – whether you have chosen the right fund, is the expense ratio reasonable, is the fund better than its peers and is it in line with your risk profile?
This might not be easy at all. That is why we at BankBazaar provide you with funds that suit your profile and needs. SIP starts at just Rs. 100. Why not invest in some of the top performing funds with us?