Which Costs You More: Direct Plan Or Regular Plan

When you think of investing in mutual funds, you can opt to buy the same fund in a direct way or the regular way from the IFA. However, as these days direct plans are being marketed as superior to the regular plan, which they indeed are. DSIJ unveils how direct plans actually fair when compared to regular plans from IFAs.



The Securities and Exchange Board of India (SEBI) had directed fund houses to launch direct version of the funds in the year 2013. Since then, you can see that a fund has two plans. One being the 'Direct' and other being the 'Regular', which is purchased through distributors. Direct plans remains the favourite of institutional investors, while the retail investors are still wary of investing through 'Direct' plan. As of April 2019, the total AUMs (Assets Under Management) of mutual fund industry stood at Rs. 25.28 lakh crore. The 'direct' mode constitutes 41 per cent of the total assets of the mutual fund industry, which constitute both institutional and retail. Most of this comes from the institutional investors. A large proportion of direct investments were in non-equity oriented schemes, where institutional investors dominate. Our analysis shows that less than five per cent of the total assets of MFs are invested by retail investors in equity-dedicated funds. This shows that the direct plans still have to find acceptance among the retail investors, despite its benefit over the regular plan. One of the reasons for such lower penetration of direct plan among retail investors is the lack of awareness among retail investors.

When it comes to direct plans, the intention of SEBI was to lower the transaction cost, bring more transparency and reduce chances of mis-selling. Direct fund was mainly focused on offering knowledgeable and sophisticated investors a low-cost product. As direct plans do not involve any commissions whatsoever, these plans have a lower expense ratio than the regular plans, which consider agent's commission in the expense ratio. Though SEBI has taken various initiatives with respect to the advertisement codes and sponsorships, there is still a need to think on various loopholes that come with direct plans.

What is a direct plan?

Direct plan is one of the modes of investing in mutual fund wherein you buy the mutual fund directly from the fund house. This may be done through the websites of the fund house, representatives or through SEBI Registered Investment Advisers (RIA) or through various investment platforms. Here, the expense ratio is lower as compared with regular plans.

What is regular plan?

Regular plan is one of the modes of investing in mutual funds wherein you buy the mutual fund from intermediaries such as banks or mutual fund distributors or independent financial advisers (IFAs) or broking houses, etc. These intermediaries receive commission from the fund houses to distribute the mutual funds. Due to the commissions involved, these plans tend to have higher expense ratio as compared to direct plans.

The Study
To understand the right approach towards regular plans and direct plans, we carried out a study wherein we compared the expense ratios of regular plans and direct plans. Also, we have compared the expense ratios after factoring in the percentage fees that investors would be paying to the fee-based RIA. On an average in the industry, a fee-based RIA charges anywhere around 1 per cent on assets, plus 18 per cent GST, apart from the upfront flat fee, which may depend upon service being opted by you.

Who is fee-based RIA?
Fee-based RIAs are those who are SEBI registered and charge an upfront flat fee. The fee-based RIA also charges a percentage on the investments that you do through them. With fee-based RIA, they usually invest on your behalf.

Who is fee-only RIA?
Fee-only RIAs are those who are SEBI registered and charge a flat fee. The fee-only RIA does not charge anything on your investments. Usually, with fee-only RIA, you yourself need to invest for which they guide you.



If we look at the difference between the expense ratio of the direct plan and that of the regular plan, then the direct plan clearly wins over the regular plan. Say, for instance, if you invest in large-cap funds via regular plan, then the Total Expense Ratio (TER) is 1.56 per cent and via direct plan, the TER is 0.82 per cent. Here, the direct plan's TER is cheaper than the regular plan's TER by 0.74 per cent.

The TER is already accounted for in the NAV (Net Asset Value) of the fund. However, the fees charged by the fee-based RIA on the assets is not accounted in the NAV and, therefore, in the returns. This is the reason fee-based RIAs or anyone providing direct plans can lure you stating the returns provided by the direct plans are more than that of the regular plans.

Now, if we account for the fees charged by the fee-based RIAs on your assets, then the situation changes altogether. After accounting for the fees charged by the fee-based RIAs, only in three instances i.e. in case of small-cap, pharmaceutical and energy funds, the direct plans score over the regular plans and that too by a thin margin, but for rest of the categories, the regular plans score over the direct plans. The difference, though, even after accounting for the fee-based RIAs fees, is not too big. However, in case of debt funds, we do not find the 'direct' plan scoring over 'regular' plan if we account for the fees charged by the fee-based RIAs.

If you look purely from the cost perspective, then fee-only RIAs would be the better option because they do not charge anything on your assets, but they may be charging a flat fee.



As stated earlier, the story changes altogether when we look at the analysis of the debt funds. If we look only at the difference between the TER of regular plans and direct plans, as in equity funds, in the debt funds also, the direct plans score over regular plans. However, when we account for the fees charged on the assets by the fee-based RIAs, then as far as debt funds are concerned, regular plans score over the direct plans by a high margin. In some cases, the difference even crosses over 1 per cent. So, in the case of debt funds, surely you are paying a premium to the fee-based RIAs.

What should be the approach?
The biggest dilemma for investors these days is whether to go via a distributor and invest in regular plans or go through the fee-based RIA and invest in the cheaper direct plans?

The study above clearly show that in most of the cases in the equity-dedicated funds, buying a direct plan through fee-based RIA will cost you more, while in the case of debt funds, it will always cost you more.

If you look purely from the cost perspective, then fee-only RIAs would be the better option because they do not charge anything on your assets, but they may be charging a flat fee. With fee-only RIAs, you have to take care of the entire execution part and the fee-only RIAs would guide and assist you, but will not execute on your behalf. This makes fee-only RIAs a costeffective option when compared with fee-based RIAs and distributors or IFAs.

The fee-only RIAs offer other benefits also. There is no conflict of interest. They would recommend products which according to them suits your requirements. These products are not restricted just to mutual funds. This is because they are free from all the biases, as they do not receive any commission from anyone. In the case of fee-based RIAs, though there is no bias in terms of products, there can be personal bias where they may only focus on increasing assets rather than providing quality advice. In the case of distributors or IFAs, there is a conflict of interest and bias with respect to the products they suggest. This means that rather than concentrating on providing quality products or services, the focus may be on maximising commission by churning your portfolio or recommending some products which may not be suitable for you.

When it comes to cost, even a combination of the fee-only RIA and distributor can prove to be a better option as you can get financial plan and advice from the fee-only RIA and get it implemented by the distributor. However, while doing so, the distributor must be completely unrelated to the fee-only RIA. You should implement the advice from the distributor of your choice.

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