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This article is more than 3 year old.

Regular vs direct mutual funds: Which is the better option?

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Today, mutual funds are considered as a better option to traditional investments.

Regular vs direct mutual funds: Which is the better option?
Mutual funds industry has been steadily seeing a growth in the last few years. As per The Securities and Exchange Board of India's (Sebi) annual report, the equity mutual funds saw inflows of Rs 1.71 lakh crore in the fiscal year 2017-2018.
Today, mutual funds are considered as a better option to traditional investments. This is due to the fact that they are professionally and actively managed, delivered superior returns in the past, have effective risk management, follow stringent regulations, provide transparency, quick liquidity, etc.
Currently, you can participate in mutual funds either through the regular option (through an advisor/distributor) or the direct option (investing directly with the AMC).
One of the biggest difference between the two is in the expenses charged by the Asset Management Company (AMC) to the investor; for e.g. – Under a regular plan, the expense ratio includes expenses towards the fund management fees, distributor fees, taxes, B-30 incentive and charges in lieu of exit load among others.
Whereas under the direct plan, the expenses are all same except distributor fees is not applicable. To put it in numbers, let’s say a Franklin India Bluechip Fund, has an expense of 2.06 percent under regular option and 1.16 percent under direct option, this difference of 0.90 percent is the distributor fees. Therefore, it is understandable that being a cheaper option, direct plans are preferred by many investors. But, here is another aspect – direct plan is not a plan for all investors:
  1. Investor profile:
  2. An average investor, who does not have a lot of surplus money will choose a direct plan as he is trying to benefit from cost efficiency.
  3. Understanding the investor risk profile: An advisor will understand the risk-return trade-off, and recommend the best fund from a universe of 3,500 open-ended and close-ended funds. Only if you are aware of your risk appetite, then you make select a suitable mutual fund. Otherwise, it would be a case of throwing arrows in the dark.
  4. Better advisory: If you are a seasoned investor and track your mutual fund portfolio actively, the direct plan is an obvious choice as you will know when to exit a fund that is underperforming or under pressure. However, there are still a majority of investors who rely on their advisor to promptly inform them if there is a need to change the fund and facilitate the process.
  5. Reviewing: Investors are also unaware of the developing changes in the financial markets. For example, in 2017, the Sebi asked the AMC to re-categorise the mutual fund schemes in a defined set of parameters. As an
  6. investor, the probability of you missing such a dynamic change in the mutual fund is higher. A prudent advisor will duly inform you of such changes and keep you updated about the impact of these on your portfolio.
  7. Investment knowledge: If you are novice investor, you may go by recommendations created by the media buzz, but the hype could soon fizzle out. If you are unaware of the financial markets function, then you could
  8. blindly be investing in an inconsistent or bad fund, which could give you poor returns. You will be experimenting with your hard-earned money.
    The other aspect is the time horizon! Direct plan investors who get the advantage of 0.90 percent will see a significant impact on their returns after 10 years. But, then it is betting against the performance of the fund, keeping track of the rules and regulations and monitoring the fund constantly. It is a tedious job!
    The following table shows you the difference in these expense structures in the differing fund performance for an average sample of 27 funds in the equity multi-cap category and the 17 in the debt credit risk category.
    The thought to ponder is for that 1 percent return differential, you may be missing out on the larger aspect - the cost of not being in the good funds could be much more than the return differential as is visible in the average difference in returns between the top 50 percent and bottom 50 percent of the universe.
    This is more relevant for equity funds as the impact cost differential of 4.5 percent exceeds the return differential of 1 percent. Equity markets undergo frequent turbulence and therefore, another layer of professionalism of advisor efficiency becomes a necessity who can analyse funds on parameters that impact its future performance. To explain this with an example – A good advisor would have given the recommendation to exit from SBI Midcap fund a year back and switched that to SBI Focused Equity, this action would have resulted in 18 percent return differential. Now, this is equal to almost 15 years of compounded benefit of being in direct versus regular on an average.
    However, moving to debt, an investor should opt for a direct plan as the return differential between direct and regular is more than the cost of being among the bottom half of the pyramid. Thus, a value-add by an advisor would be almost equivalent to return differential.
    This is broadly being followed by the industry today where even the veterans prefer the Advisor route (or the regular route) for equity investments whereas Direct route for Debt as per data from Amfi:
    Thus, if you want to invest in debt mutual fund, then going through the direct option is sensible. However, when it comes to equity investment, not seeking a professional advice for cost-benefit, is almost like misfiring, just at the time of winning a game.
    Feroze Azeez is deputy CEO of AnandRathi Private Wealth Management.
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