Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Direct plans outperform, but challenges remain

For majority of retail investors, intensive education initiatives from all stakeholders is needed

Direct plans are Securities and Exchange Board of India’s (Sebi’s) gift to mutual fund investors who prefer buying directly from asset management companies (AMCs) at a lower cost vis-a-vis regular plans bought through a distributor. A study on returns from direct plans since their launch on 1 January reveals that they have outperformed regular plans.

While some well-informed investors such as companies and high net worth individuals (HNIs) have made the shift, the rest have adopted a wait-and-watch approach. This is clearly visible in the assets under management (AUMs) data for the quarter ended March 2013. The data indicates that 15% of the industry’s AUM has shifted to direct plans.

ELSS leads

The best outperformance is seen in the equity-linked savings scheme (ELSS) category at 0.73% annualized. A higher difference in returns between direct and regular plans indicates that distribution expenses (commissions) in this category are higher. This is because of the tax season during the period and also the fact that assets are locked for three years to avail tax benefits. ELSS is followed by monthly income plans (MIPs)—aggressive and balanced categories. MIPs are the flavour owing to high debt component of 70-100% as this asset class is expected to perform well as interest rates decline (net asset values, or NAVs, and interest rates move in opposite directions). The 10-year government bond yield has fallen from 8.05% on 31 December 2012 to 7.95% on 28 March 2013. The category would doubly benefit if equities also rise.

AUM shift more from liquid funds

The industry saw 15% of its AUM shifting to direct plans for the quarter ended March 2013. Interest in direct plans was higher in fixed-income categories as a majority of investors in these categories are institutional (companies and banks). Liquid and ultra short-term debt funds saw 44% and 19% of their AUM, respectively, shifting to direct plans in the quarter. Equity categories, on the other hand, have not seen a significant shift as the investors are mainly retail. At an AMC level, top five AMCs saw 7-16% of their AUM shift to direct plans, while some small AMCs saw a shift of at least 60%.

High exit loads for switching

The study also observed that most AMCs charge exit loads for switching from regular plans (with a distributor code) to direct plans (of the same scheme) if the application is made within the exit load period. Some have even increased exit loads from 1% to 3% and/or extended the period for which exit loads would be applicable to as high as 720 days.

While the difference in expense ratios between direct and regular plans, as disclosed by AMCs, ranges between 0.5% and 1.5% in the equity category, the difference in case of pure debt funds ranges from a few basis points to 1.25%. This difference will clearly be reflected in the returns posted by direct plans vis-a-vis regular plans.

The challenges

However, a few challenges remain. First, investors would need to be well-informed to choose the schemes to invest. Second, direct plans are not available on a common platform and one would need to visit individual AMC websites to purchase these plans. Institutional investors and HNIs may find it easier to do so, thanks to their internal processes and advisers, respectively. Companies that depended on distributors to get free services such as daily performance updates and newsletters to make investment decisions, would need to invest in research and risk management tools or outsource these services to credible and independent research providers.

Less-informed retail investors would need the services of independent mutual fund advisers which would come for a fee. Currently, most investors avail such services from distributors for free, who in turn are reimbursed by AMCs through commissions. An alternative is to use mutual fund rankings available free of charge from independent research providers where investors can choose top-performing funds and invest directly.

The switch to direct plans would suit well-informed investors to begin with. For the majority of retail investors, intensive education initiatives from all stakeholders as well as strong advisory support are needed. For the new breed of investors (from tier II and tier III towns), distributors would need to lead till the industry reaches a reasonable level of penetration and investor education.

Mukesh Agarwal is president, Crisil Research.