Ever since 2013, the industry regulator, SEBI, enforced the rule of direct plans, for each and every scheme, co-existing with the regular plans.
What’s the difference between the two?
By design, direct and regular plans will have separate net asset values, or NAVs, an outcome of the lower expense ratio of direct plans. This is because direct plans exclude distribution expenses and pay no commission.
Agents earn two types of commissions from mutual funds. There could be an upfront commission which is not paid by you, but by the asset management company, or AMC, out of its own pocket. In addition, there is a trail commission (included in the fund's expense ratio) paid to the agent for every year you stay invested in the fund. By buying a direct plan, you avoid such commissions.
Simply put, direct plan pools are treated as separate from the ones accumulated via distributors to which commissions and distribution charges will be applicable, thus requiring a separate NAV. In effect, investors in direct plans are being rewarded for making efforts for selecting their schemes and approaching the AMC directly to invest.
In the case of equity schemes, expense ratios can differ from anywhere between 25 and 100 basis points (the gap will be lower for debt schemes). For instance, HDFC Equity (G) has an expense ratio of 2.17%, while HDFC Equity (G) Direct Plan has an expense ratio of 1.51%. The NAV of the direct plan is Rs 486.13 while that of the regular plan is Rs 477.37.
How does this translate into returns?
Let's say Investor A invests Rs 10,000 lump sum in an equity scheme’s direct plan which gives him a return of 15% annually. Over 15 years, this would amount to Rs 81,371. Investor Z invests the identical amount in the identical scheme but via the regular plan; as a result, he bears an expense ratio which is higher than that of the direct plan by 50 bps. Thus, in the same period, he will earn lower returns (14.5%), which would amount to Rs 76,222, a difference of 6.33% between the resulting amounts of both plans.
If one takes another example, ICICI Prudential Focused Bluechip Equity, the direct plan has an expense ratio of 1.50% as against 2.29% in the case of a regular plan, which translates into a difference of 0.79%.
When investing in a direct plan, the investor needs to directly approach the AMC (physically or online) or via an authorised investor service centre. In the application, the investor needs to mention ‘Direct’ in the ARN Code section. In the case of those employing the services of an intermediary (distributor, financial adviser, bank or online portal), the latter’s ARN Code will be mentioned on the form.
3 things you must know about direct plans:
- Investments under the direct plan are open to all investors who invest without a distributor.
- Characteristics such as the composition of the portfolio, investment objective, asset allocation pattern, investment strategy, exit load, risk factors, and other terms and conditions are identical for direct and regular plans of the same scheme.
- The NAV would differ between the two plans plans.
3 reasons to opt for a direct plan:
- You are well versed with fund investing with access to unbiased research and do not need the help of a distributor. If you are taking the help of a distributor in understanding the types of schemes and which one suits you, then you should invest via a regular plan and route it via the distributor.
- Alternatively, you may be using the services of a financial adviser who adds tremendous value to your portfolio and guides you as to what fund to invest in. However, the adviser does not offer transactional capabilities but opts for the fee-based route. In that case, use the direct plan when implementing his recommendations.
- You may also have a portfolio that is up and running and on track towards achieving your goals. However, you may want to invest in a thematic fund for tactical reasons. In that case, the direct route makes sense.
