Direct plans were introduced by Sebi five years ago as a low-cost alternative to regular plans, sold through intermediaries. The former allows purchase of funds at a lower cost, as it eliminates the expense on distributor commissions. The commissions on equity funds—including the up front commission and annual recurring payout—typically vary between 0.75%-1.25% annually. The cost differential between the direct and regular plan should ideally be equivalent to this expense.
However, data shows the difference in the expense ratios of the two variants is much narrower. Among the 143-odd diversified equity funds on offer, 72 have a cost differential of less than 100 bps between the direct and regular plans. The gap in the two variants is narrower than 75 bps for as many as 38 schemes. This raises concerns that investors are actually being overcharged despite taking the direct route as fund houses are not passing on the benefits of culling the commission expense.
The difference in costs of regular and direct plans is down in some funds
Some of these schemes may have cut down on distributor commission in the regular plan
The cost differential for several funds has narrowed over the past few years. As many as 41 schemes are now offering a smaller gap in costs between the regular and direct plans. Experts say there is merit in the regulator’s observations on direct plans. Suresh Sadagopan, Founder, Ladder 7 Financial Advisories, asserts, “The record of several fund houses in direct plans is patchy with significant variation in cost differential even within the same fund house.” Rohit Shah, CEO, Getting You Rich, adds, “The pricing of direct plans is often not consistent and investors may be overpaying to some extent.”
Schemes with the lowest difference in costs
Schemes with the highest difference in costs
*As on 31 July. Schemes with corpus above Rs 100 cr considered. TER is total expense ratio. The difference in TER of direct plan and regular plan is the percentage points difference. Source: Ace MF
Another concern is that while some fund companies have slashed the expense ratio in regular plans, they are not bringing down costs in direct plans the same way. While 56 schemes have seen a fall in expense ratio for regular plans compared to three years ago, 13 of the schemes have raised costs for the direct investor.
Experts say if there is scope for reducing costs for the regular plan, it should also translate into lower costs for the direct plan. Overall, 59 schemes are now charging more for direct plans than three years ago even as 82 schemes have raised the costs for regular plan over the same period. The CEO of a mid-sized asset management company points to blatant tinkering of costs by some fund houses. “By playing around with the fund management fee and taking advantage of the fungibility allowed by Sebi in charging the expense ratio, few fund companies may be keeping costs artificially high for direct plans,” he says. This is visible in some schemes, where the stated fund management fee as percentage of the scheme corpus is higher for the direct plan.
What should investors do?
Direct plans are attractive because of the cost savings they offer relative to the regular plan, allowing the investor to build a bigger corpus over time. The impact of higher expense on returns can be significant.
Even so, direct plans are meant for investors who are well-versed with the market and can devote their time to identify the right scheme and monitor performance. But for the vast majority who do not understand the risks involved and cannot keep track of fund performance, it is best to invest through an adviser. If the cost differential between the regular and direct plans is not sufficiently large, the benefits of guidance from an adviser will far outweigh the savings offered by direct plans. “The difference between the direct and regular plan should ideally be more than 1% to materially benefit the investor,” says Shah.