Direct plans charge lower expenses from you and so can generate higher returns than regular plans
Tarun from Mumbai writes he wants to buy a multicap cap fund through the Direct plan but his ‘advisor’ said if he goes for Direct plan, the cost value will be more than the Regular plan of the same fund. Tarun is not alone. Many readers often write to us how direct plan NAV of a mutual fund seems more steeply priced than the regular plan.
Some are even misled into believing that since the direct plan NAV appears higher than regular plan NAV, investors lose out on ‘extra’ mutual fund units since direct fund investors get a lower number of units. There are many half-truths in the mutual fund world, and in this article we will clarify a few points. But to begin with, let us reiterate that Direct plans charge lower expenses and so can generate higher returns than regular plans. This is the reason why ‘going direct’ gives suitable investors always a better chance to out-perform MF benchmark the longer you remain invested. Read on to know more.
Direct – Going ‘directly’ to the fund-house to buy a scheme means that you are not going through a distributor and therefore the expense ratio deducted is lower (because it does not include any commission). Simply put, with the direct MF plan, you can save a little more money. The money saved from buying ‘direct’ can translate into something significant if you are going to remain invested in the mutual fund for a long period.
Regular – In a regular plan, the MF company pays an incentive to the distributor/broker and this goes out from your share. In mutual fund lingo, the expense ratio is higher for a regular plan compared to a direct plan. Hence the returns tend to be higher for direct plans compared to regular plans.
Suitability – A regular plan suits investors who do not have the knowledge about MFs nor have the time to monitor their MF portfolio. But if the investor is well-informed and manages their own MF portfolio, they do not need any intermediary and should go ‘direct’.
Always remember that the portfolios of direct plans are identical to that of the regular plans. So, from portfolio and management perspectives, there is really no difference.
Coming to the question on whether the direct plan NAV of a mutual fund is more steeply priced than the regular plan, the answer is yes if you look at the NAV number. But do not misunderstand the NAV difference.
Yes, it is true that direct plan NAVs are higher than regular plans, but that is because direct plans cost less than regular plans. And, it is this lower expense that ultimately help ‘Direct investors’ to earn more returns and beat benchmark more often than ‘regular investors.
If you are buying an ELSS (tax-saving MF), the average NAV difference is nearly 12% between Direct and Regular of the same scheme.
In case of Largecap funds, Direct plan NAV is on average 7.5% more than Regular plan NAV.
In case of Midcap funds, Direct plan NAV on average is 7% more than Regular plan NAV of the same scheme.
In case of Multicap funds, Direct plan NAV on average is 6% more than Regular plan NAV of the same scheme.
And in case of Smallcap funds, Direct plan NAV on average is 5.8% more than Regular plan NAV of the same scheme.
The above numbers are real and have been arrived at from a set of 145 open-ended actively managed equity funds in 5 categories.
Starting January 2013, fund-houses were asked to launch a ‘direct plan’ version that will be exactly the same as the ‘regular’ plan, but will charge a lesser expense ratio. As per SEBI rules, the base total expense ratio (TER) of direct plan shall have a lower expense ratio excluding distribution expenses, commission, etc., and no commission shall be paid from such plans.
Typically, we see that higher-risk equity fund categories have higher expense ratios when it comes to regular plans. Examples are smallcap, midcap funds. Direct plans charge lower expense ratios.
The expense ratio gap between largecap fund regular plan and largecap direct plan is on average 1%. For ELSS funds, the average gap is 1.1%.
For multicap and midcap funds, regular plans charge 1.15% more than direct plans. And for smallcap funds, the gap is 1.3%.
Absolute return numbers may make news, but actively-managed investments we believe should ideally be seen in the context of alpha generation. What is alpha generation? The excess return your fund has delivered over the fund’s benchmark.
If your fund has given 10% CAGR and the benchmark has given 12% CAGR, even 10% is not good. Why? Because you have paid the fund manager good money to out-perform. Otherwise, you could have simply bought an index fund or an exchange traded fund (ETF) to get market-like returns.
We studied a set of 145 open-ended actively managed equity funds in five categories – ELSS, Multicap, Largecap, Midcap and Smallcap. These funds manage over Rs 5.4 lakh crore investor assets. So, they can be considered a representation of the equity MF universe.
|Equity fund category||% of funds beating benchmark|
ELSS – Our study shows that in a 1-year period, 41% of direct plans beat their benchmark compared to 38% of regular plans. In the 3 year period, 36% of direct plans beat benchmark compared to 24% regular plans. In the 5 year period, 43% of direct plans beat their benchmark compared to 17% of regular plans.
Largecap – Here in 1 year period, 30% of direct plans out-perform benchmark compared to 23% in regular plans. In the 3-year period, 25% of direct plans beat the benchmark compared to just 7% regular plans. In the 5-year period, 33% of direct plans delivered alpha compared to 11% in regular plans.
Multicap – In 1 year period, 26% of direct plans in the multicap category beat the benchmark index compared to 21% in regular plans. In the 3-year period, 36% of direct plans beat benchmark than just 18% of regular plans. In the 5-year period, 44% of direct plans outshined benchmark compared to 30% of regular plans.
As you can see, the percentage of funds beating the benchmark in ELSS, Largecap and Multicap category is low. But even then, ‘direct plan’ can always be expected to have a higher probability to beat the benchmark due to lower costs compared to ‘regular plan’.
In Midcap and Smallcap funds, especially in 3 and 5 year periods, the % of funds out-performing respective benchmark is higher. This could also be a function of easy to beat benchmarks!
Midcap – In 1 year period, 67% of direct plans beat benchmark compared to 58% of regular plans. In the 3 year period, 73% of midcap direct plans beat benchmark vis a vis 68% of regular midcap funds. In the 5-year period, the same 52% of direct and regular plans beat benchmark.
Smallcap – In 1 year period, 62% of smallcap direct plans beat benchmark compared to 52% regular plans. In 3-year period, 93% of direct plans in this category beat benchmark compared to 80% of regular plans. And in 5-year space, 100% of smallcap direct plans beat their benchmark compared to 86% of regular plans.
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