Within just 7.5 years of their introduction, direct plans now constitute about 19% of the mutual fund AUM held by the individual investors. For the overall industry, the share of direct plans in the overall mutual fund AUM was about 47% as of June 2020. Let us explore the reasons behind the growing acceptability of direct plans and its advantages and scope for investors.
Why are direct plans gaining popularity among individual investors?
Increased financial awareness is one of the primary reasons for the growing popularity of direct plans. Armed with the ease of online investing and improved access to information on various market dynamics, individual investors are increasingly preferring to make their own investment decisions. Consistent promotion of direct plans by various market participants has also played a major role in increasing the popularity of direct plans across all investor segments.
With the emergence of new business models, many financial marketplaces started offering direct plans to retail investors without charging any fee for it. This has improved the access of retail investors to direct plans.
How do direct plans differ from regular plans?
Regular and direct plans of a mutual fund scheme have the same investment objective, investment strategy, asset allocation policy, portfolio composition and fund management. As with the regular plans, investors of direct and regular plans can choose between growth, dividend and dividend re-investment options and choose between lump sum, SIP and STP modes of investing. Regular and direct plans only differ in terms of their NAVs, expense ratios and rate of returns.
Expense ratio : This ratio denotes the percentage of the average daily net assets of a mutual fund scheme used for meeting its annual operating expenses. The operating expenses include the various costs incurred for fund management, advertising, administration and commissions to the distributors and agents. As the mutual fund houses do not have to pay any commissions to distributors selling direct plans, their operating expenses are lower than their regular counterparts. This translates into lower expense ratio. Depending on the fund category, the expense ratios of direct plans are up to 1% lower than their regular counterparts.
Net Asset Value : As the operating expenses are directly deducted from the net AUM of the mutual funds, lower expense ratios of direct plans results leads them to register higher NAV. As the time progresses, the gap between the NAV of regular and direct plans becomes wider.
Lower expense ratio of direct plans help them in generating higher returns. As the savings in operating expenses by direct plans stay invested, the savings themselves starts generating returns. Due to the power of compounding, the gap between the returns from direct plans and regular also become wider.
By how far do direct plans outperform regular plans?
The scale of outperformance by direct plans over regular plans will primarily depend on the difference in their operating expenses ratio and the period of investments. Longer the investment horizon, greater would be the outperformance.
For example, assume that you invest Rs 20,000 through SIP in the regular plan of an equity fund having a 2% expense ratio for 30 years. If it generates an average annualised return of 12%, the corpus will grow to Rs 4.14 crore at the end of your SIP tenure.
If the same amount is invested in the direct plan of the same fund having 1% expense ratio for the same tenure, then the corpus will grow to about Rs 5.17 crore at the end of the SIP tenure. The difference in their corpuses will be a staggering Rs 1.03 crore. The regular plan will be outperformed by its direct counterpart by around 20%.
Where can one buy direct plans?
Investors were initially able to purchase direct plans from the mutual fund houses and their respective RTA (Registrar & Transfer Agent), both via physical application or online. However, this procedure is cumbersome given that the investor has to apply with each fund house or RTAs separately. This leads to the duplication of paperwork or creation of multiple passwords and IDs in case of online investing.
With the advent of various financial intermediaries and investment advisors into the direct plan space, investors got the option of purchasing direct plans through a single medium in lieu of an advisory fee. This fee is directly paid to the advisor or the concerned marketplace and not deducted from the funds’ NAVs.
Who should invest in direct plans?
Direct plan was initially introduced for DIY investors. The idea was to save them from incurring cost on investment advisory that they do not need. However, this idea has led to a wrong notion that direct plans are not suitable for the first time investors or for those requiring handholding while making investment decisions.
Some of the online financial marketplaces offering direct plans also offer personalised investment advisory services for free. They also offer free market insights, fund recommendations and online calculators and tools to enable informed investment decision-making. Thus, investors lacking the skill set for fund selection or requiring investment advisory can still invest in direct plans with optimal decision-making at absolutely zero cost.
(The writer is Director & Group Head, Investments, Paisabazaar.com)