Active Stocks
Fri Apr 12 2024 15:57:45
  1. Tata Steel share price
  2. 163.50 -1.00%
  1. NTPC share price
  2. 362.00 -0.32%
  1. ITC share price
  2. 430.10 -1.56%
  1. HDFC Bank share price
  2. 1,518.90 -1.10%
  1. State Bank Of India share price
  2. 766.75 -1.57%
Business News/ Money / Personal-finance/  Direct plans are not as cheap as you think

Direct plans are not as cheap as you think

You can buy into a regular or direct plan of a mutual fund scheme. Direct plans are cheaper, but you may still want to shift to the regular plan

Photo: iStockphotoPremium
Photo: iStockphoto

If you are a do-it-yourself long-term equity mutual fund (MF) investor, you want to buy a fund at the lowest possible cost and then hold it for as long as you need to. Ideally, you would go for the direct plan of a scheme because the expenses, or the cost, is lower than a regular plan. But did you know that a year later your cost embedded in the direct plan could change?

It could go up or even fall by 30-40 basis points (bps). In either event, you should be aware of the change in case you decide to switch funds. One basis point is one-hundredth of a percentage point.

Cost isn’t the primary factor for investing in an equity fund, but it matters. In case of MFs, the impact is higher as costs can vary (subject to an upper limit) between different schemes.

Expense ratio is the cost expressed as a percentage of assets that would be deducted by MFs; the ratio is an annual figure but gets reflected in the daily net asset value of a scheme. Out of a set of 144 diversified equity schemes whose direct plans we looked at, for at least 64 schemes the expense ratio between July 2015 and June 2016 is up more than 10bps. At least 20 funds have seen a jump of more than 50bps. That is a substantial change to ignore. Many of these funds have performed well so you can’t ignore them.

While the cost of direct plans will always be lower than regular plans, it can increase and you need to keep track of them, as returns are net of costs.

Each MF scheme—be it equity or debt—has two plans on offer, regular and direct. The direct plan cost is lower than the regular plan to the extent of commissions paid to distributors. In both the cases, you are buying into the same portfolio but at different costs.

Expense ratio matters as it takes away from your overall return. The higher the expense ratio, the lower will be your net return. The objective of choosing the direct plan is to benefit from lower costs, but what if this cost itself increases substantially? You could, alternatively, choose a similar scheme with lower expenses. If the gap between the direct and the regular plan drops too much, it makes sense to opt for a distributor offering value-added services.

Let’s take the case of Birla Sunlife Frontline Equity Fund, the largest in size among large- cap equity funds (according to One-year return for its regular plan was 5.48%, and that is net of 2.27% charged as expense. Return for the direct plan was 6.52%, after netting expenses of 1.38%. The difference in expense was 0.89% and over 10 years that can compound to a 9.2% advantage. (Expense data is for June 2016, not average for the year.)

“Expense ratios should be looked in comparison with a peer set, there you may not see too much variance. But when you look at the direct versus regular plan expense ratios of the same scheme, a difference of 100bps can add up to a lot over 15-20 years," said Kaustubh Belapurkar, director fund research, Morningstar Investment Adviser.

If costs for direct plans go up, your returns advantage will shrink. This is especially true in case the gap between direct expenses and total expenses of the same scheme is reducing. Then you have to choose, should you put in your time and effort in the direct plan or go with the value-added services of a distributor, as the difference in costs isn’t substantial.

“If the difference between direct and regular plan falls below 50bps, we rethink offering the direct plan as an option, as many services that we provide can be beneficial at such a low-cost differential," said Suresh Sadagopan, a Mumbai-based financial planner.

There is also a large variance in direct plan expense ratios across schemes. Among the funds that Mint Money examined, the direct plan expense ratios vary from around 1% to 2.5% annually. This might be a result of size. Also, the gap between direct and regular plans of a scheme can vary substantially across funds.

“We do check expenses data periodically, given that there is a vast divergence across schemes. While there are schemes with a difference of just 20-30bps between the direct and regular plans, for others the difference can be as high as 100bps or more," said Sadagopan.

There may be both technical and strategic reasons behind a change in expense ratios.

“Direct expense ratio can increase if overall expense ratio becomes higher and at the same time distribution commission is lower. Increased contributions from B15 locations (beyond the top 15 cities in the country) could also lead to higher direct expense ratio," said a senior executive from a mid-sized asset management company (AMC).

MF schemes charge expenses in a tiered structure, as per guidelines prescribed by the Securities and Exchange Board of India (Sebi). As more assets get added, the incremental expense ratio is lowered. Ideally, a scheme which is growing in size should see lower not higher expenses. But it doesn’t always happen.

For equity funds, the maximum expense ratio chargeable is 2.5%, plus 20bps can be charged in lieu of exit load and another 30bps can be charged for inflows garnered from B15 locations, taking the upper limit to 3%. All these factors can lead to a surge in the overall expense ratio.

Apart from these, accounting factors can also have an impact. For example, whether the service tax charged on management fee is reflected in overall expenses or not, will also make a difference.

Typically, the monthly expense ratios declared in the fact sheet are considered (we too looked at these), but this could vary from the annual expense ratio in the annual report. It’s worth considering that many of the schemes we analysed have a noted increase in expense ratios starting from April 2016, which also marks the start of the new financial year. How expenses average out through the rest of this year, remains to be seen.

Despite all these variables, there are schemes where no change has occurred in either the regular or the direct plan expense ratio.

“We have never felt the need to change the expense ratio. As assets increase, ideally expense ratios should get lower," said a chief executive officer of a mid-sized AMC.

Industry experts point out that within the prescribed limits, it is the prerogative of the fund house to keep scheme expenses low or high. If the total expense ratio for a scheme is raised within its permissible limits, then the direct plan expenses will increase as well.

However, lower distribution commission should ideally pull down the total expenses rather than leading to higher direct plan expense ratios. But data we examined didn’t indicate this.

“We all started at different levels for direct expense ratios. As commissions got rationalised over time, the industry has settled with a difference of around 70-100 bps between direct and regular plan expenses. We are maintaining our competitiveness in the space," said Karan Datta, chief business officer, Axis Asset Management Co. Ltd.

As the direct plan gets more popular, assets will increase. A year ago it may not have been a large part of an AMC’s portfolio and didn’t influence pricing much. Experts also said that where more institutional money is involved, there is a likelihood of expense ratios getting lowered but this may be temporary.

For long-term investors, just as returns compound, annual costs also compound. This is the advantage of well-priced direct plans—they give self-guided investors a return boost. However, if competitiveness makes the gap between direct and regular expenses too low, then the benefits of having a distributor to assist with investments can overshadow the cost saving in a direct plan.

Mint Money has always maintained that direct MF plans aren’t meant for all investors. Don’t simply jump after low cost. Understand your needs first. If you are a first-time investor, it’s best to go through a distributor or adviser and opt for a plan accordingly.

Direct plans may also not be the best option for experienced investors who don’t have the time for building an MF portfolio. If you are a seasoned investor who has found the right platform to access direct plans, keep in mind that expense ratios are dynamic and it is prudent to add it to the tracking list along with performance and risk parameters.

Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less
Published: 15 Aug 2016, 07:21 PM IST
Next Story footLogo
Recommended For You
Switch to the Mint app for fast and personalized news - Get App