Should you invest directly or through a distributor?

Readers have been querying us on the distinction of a direct plan since many of them used to invest directly without a distributor. Divyansh Awasthi tells you what’s different now.
By Divyansh Awasthi |  13-11-13 | 
 
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About the Author
Divyansh Awasthi is an Investment Analyst with Morningstar. He would like to hear from you, but cannot give financial advice.

Direct plans came into effect from January 1, 2013 to co-exist along with the regular plans which can be dubbed distributor plans. Here’s what you need to know.

How the direct route evolved

Years ago, the Securities and Exchange Board of India had mandated that investors approaching the asset management companies directly, rather than through distributors, should not be charged the entry load of 2-2.25%. For those who planned to invest directly, this was a definite saving.

Later, in 2009, the saving on this direct route option was nullified because the regulator scrapped entry loads altogether making it a level playing field for all investors. Since AMCs passed on the entire entry load to distributors, who played a pivotal role in getting investors to subscribe to mutual fund schemes, this was an attempt to pave the way for advice-based pricing.

In 2012, the regulator endorsed two types of plans, which came into effect this year. All AMCs had to mandatorily provide separate direct plans under new and existing schemes. These could be subscribed to by investors directly without going through a distributor. What’s the difference this time around? The expense ratio on the scheme would differ.

How it matters

By design, direct and distributor plans will have separate net asset values, an outcome of the lower expense ratio of direct plans. This is because direct plans exclude distribution expenses, and further, no commission is paid from these plans.

Simply put, such 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 these newly minted plans are being rewarded for making efforts for selecting their schemes and approaching the AMC directly to invest. It is important to note, however, that the portfolio of both the plans will remain the same.

Let me elaborate. For equity schemes, expense ratios can differ by anywhere between 25 to 100 basis points (the gap will be lower for debt schemes). 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 distributor 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.

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 advisor, bank or online portal), the latter’s ARN Code will be mentioned on the form.

Which way?

Before you logically conclude that investing via a direct plan is the smarter way to go, hold on. Even if you follow the strategic rules of thumb: prepare an asset allocation, diversify, and think long-term; there are thousands of schemes on offer from 44 asset management companies. Are you capable of differentiating between all the schemes in the industry? Even so, you will need to put in time and effort to research and create a shortlist of schemes. If you have answered in the affirmative, go ahead. To help such individuals, the independent analysts at Morningstar have whittled the options down to a select few. You can even check the fund ratings to guide you. Click here to screen funds and compare them.

New investors with little investment experience would do well to consult an advisor. It may be worth the extra return forgone. Cheaper is not always the better option. Apart from providing advice, the advisor will also manage your money, thus saving you the effort of visiting the asset management company physically. But choose wisely. Getting the right advisor may make all the difference between superior and average returns from your fund portfolio.

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