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Sunday, August 18, 2013

What are Direct Mutual Funds in India

Mutual fund investors have definitely turned smarter. An increasing number are taking the direct investments route to spice up their returns. Indeed, going by a Crisil report, direct plans now constitute 25% of the assets under management (AUM) of mutual funds. If you invest in mutual funds and plan to do so, you better understand what is a Direct Plan for every mutual fund scheme.

What is a "Direct Plan"?
SEBI has directed Mutual Funds vide a 2012 circular to provide a separate plan for direct investments, In the direct investment route, the investor goes to the fund house directly, thereby cutting out the distributors and other middlemen. This, in turn, brings down the administration and distribution expenses, which pulls down the expense ratio and makes your fund’s performance better. This is valid for existing as well as new schemes.

When have the "Direct Plans" been launched?
The "Direct Plans" were launched with effect from January 1, 2013.

What was the need for a Direct Plan?
As your agent/advisor was being paid on every sale, his motivation would be to make you constantly buy more mutual funds and this would be possible by churning your portfolio. On his recommendation, an investor would buy some units of a mutual fund today, sell them after some time, buy another mutual fund, sell that too after some time and so on; so that the agent/advisor/distributor keeps earning commission. Further as the commission was different for different schemes of mutual funds, it was quite common to see the agent community advising schemes with higher commission to investors over other schemes, irrespective of whether the scheme was any good for the investor or suited his requirements or not.

Who can apply under the Direct Plan?
Investments under the Direct Plan are open to all categories of investors who choose to invest without routing the transaction via a distributor.

How many plans will be available with effect from January 1, 2013?
All Plans / Options / Sub-Options offered currently under "Existing Plans" of the Schemes are also available for subscription under the "Direct Plan". Thus, there shall be 2 plans available for subscription under the schemes viz. Existing Plan and Direct Plan.

What is the difference between the "Existing Plan" and "Direct Plan"?
The "Direct Plan" has a lower expense ratio as compared to existing plans in the same schemes, as there is no commission to be paid to the distributor under this plan. Expense ratio refers to the amount of money that an asset management company charges investors towards operating and administrative expenses. If you choose to invest directly, the expense ratio of a direct plan will be 0.25-0.75% lower. The Crisil report points out that as a result of choosing the direct route, investors have gained an additional 0.08-0.76% compared with the regular plans.

Is there a difference in the NAVs between the Direct and the Existing Plan?
Yes. Since there is a difference in the expenses charged by the Direct and Existing Plans under every scheme, there will be a difference in the NAVs for both these Plans.

Will the scheme characteristics change in the "Direct Plan"?
No, scheme characteristics such as Investment Objective, Asset Allocation Pattern, Investment Strategy, risk factors, facilities offered and terms and conditions including load structure will be the same.

Was this not available earlier?
Investment via the direct route was allowed earlier too, but the Securities and Exchange Board of India has incentivised this route since the start of this year. Since January, fund houses are supposed to declare separate net asset value for regular and direct plans.
Originally, till a few years ago, when you made an investment of Rs.100 into a mutual fund, between Rs.1 to Rs.2.50 used to be deducted as an entry load. This entry load was primarily the commission that was paid to the intermediary you went through to invest in this mutual fund your distributor, agent, online portal, financial advisor, bank etc. So in effect you were actually putting in only Rs.97.50 to Rs.99 into the mutual fund.

What will happen to my existing investments which are not routed through distributors?
Such investments will continue to be under the "Existing plan". In case you wish to transfer them to the Direct Plan of the same scheme, you may submit a switch request. Such switches may not be subject to exit load. However, investors should consult their professional tax advisor before initiating such requests.

Why are my existing investments not automatically transferred to the Direct Plan?
Existing investments cannot be transferred automatically under the Direct Plan, since plans are available for fresh / new investments only. Existing investments would continue to be a part of the existing scheme and you can switch them into the Direct Plan. Please note that such switches may entail exit load / tax consequences which need to be considered and understood before proceeding.

Can I invest in the Direct Plan vide the stock exchange platforms (BSE or NSE)?
Since the stock exchange platforms necessitate routing transactions through distributors, these platforms can not be used for investing in the direct plans. However, investors holding units in the demat mode can redeem units in these plans from their demat account using the stock exchange platforms.

Whats the trend?
Within six months of their launch, direct plans of mutual funds have cornered 25% of the total AUM of the industry. There has been a lot of institutional investors who have taken the direct route, but the direct participation from retail investors is still not very high. This is because most of them rely on financial advisors for suggestions regarding mutual funds. going ahead, as awareness increases, retail investors too could start shifting to these plans.

How have the direct plans been performing wrt NAV?
When mutual funds launched direct plans earlier this month, these schemes were expected to do better than the regular funds because of the lower charges. The difference was expected to show up after a few weeks, even months. However, within a week, the direct plans of some funds have raced ahead of the existing schemes. The extent of the out-performance is eye-popping. In some funds, such as Kotak Tax Saver, the difference is more than 1 percentage point. Even among 5-star funds, direct plans have outperformed regular funds by as much as 38 basis points. It's noteworthy that the degree of out-performance is high among equity funds.

Is there any catch?
You don’t have the expertise and experience of the advisor/agent to rely on for an appropriate and suitable selection of the mutual fund schemes. The difference in returns of a scheme that is in the Top 10 in its category and one that is say even the 17th or 18th can be large. So if you go the Direct Plan route you will need to equip yourself with the knowledge to understand how mutual funds work, how the share market is doing, evaluate track records of fund houses and fund managers and most of all you will need to have the time to devote to research to be able to invest well.

The Future...
As we move on, the change from a commission based model to a fee based model is inevitable as in developed economies of the world. At some stage while you invest directly in a mutual fund without any intermediaries, you will be doing so on the recommendation of a financial planner/advisor and paying a fee for his services.


Manoj Arora
Lead a Financially Free Life !!

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