Mutual Fund Industry
| March 09
Direct plans of mutual fund are an alternative investment option to the regular plans. As the name suggests, in this option you circumvent the intermediary and invest directly with the fund house. Introduced by SEBI in 2013, as a disintermediary step, mainly to help retail investors get more for their investments by eliminating commissions from the expense ratio. The need for this was majorly felt due to the advent of technology, which opened a world of knowledge on mutual funds and their peripheries. However, the awareness of the existence of direct plans is still quite nascent. The clear distinction between direct plans vs. regular plans can be summarised in the following points.
1. Expense ratio
Expense ratio refers to the annual percentage of the fund’s assets that is paid out as expenses. These expenses include management fees, marketing expenses, operational costs, and distribution fees.
Regular plans have a higher expense ratio because the AMC`s include the commissions which they pay the distributors as an incentive to promote and sell their schemes. These commissions are approximately 40-60% of the total expense ratio of the scheme.
The expense ratio for Direct plans is lower than regular plans as there are no distributor fees involved. Typically expense ratios in equity funds are lower by 0.75% to 1.5%, debt funds are lower by 0.5% to 1% and liquid funds are lower by 0.1% to 0.5%. Investors directly benefit from this as AMC`s transfer savings in expense ratio to the investor’s returns. This meek sounding number could be the difference between a good and a great life.
The net asset value (NAV) of direct and regular plans differ as a result of the variation in expense ratios. The NAV of direct plans is relatively higher than regular plans. However, this does not mean that direct plans are more expensive, it just means that the direct schemes have given a higher appreciation on investment and hence, their NAVs have grown higher. For example, the HDFC Balanced fund’s NAV is 127.1 in regular plans and 131.5 for direct plans.
Due to lower expense ratio, the direct plans of mutual funds generate higher returns as compared to regular plans. Depending on the expense ratio this difference in returns could be as high as 1.5% annually. Needless to say, that due to the power of compounding this 1.5% could swell into a sizable amount over a long period of time.
Reconsidering the example of HDFC Balanced Fund (G), this fund at the end of December 2016 gave returns of 18.30% in the regular plans and 19.39% in direct plans. The difference in the expense ratio regular vs. direct is 1%.
That means if you invested Rs. 10000 per month for the next 15 years in HDFC Balanced Fund and the returns remain the same, your corpus in regular plans would have grown to Rs. 69,69,265. However, in the direct plans your investments would have grown to Rs. 76,33,650. A whopping difference of Rs. 6,64,264. You can only imagine if the expense ratio increases just by 0.5% the corpus will multiply accordingly.
Direct plans definitely have more benefits
than regular plans. However, some doubters downplay the benefits by saying that direct plans are DIY mutual funds and are complex to invest in. Do not fear, MoneyFront is here. We have a comprehensive automated advisory
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