The Mutual Fund Show: The Pros & Cons Of Direct And Regular Investing
Every mutual fund in India offers a direct and a regular plan—having the same scheme, run by same fund managers and invest in same stocks and bonds, but with one difference.
A direct plan offers better returns for the same investment and costs less, according to Kunal Bajaj, head of wealth management at MobiKwik.
“There’s no commission in a direct plan. What investors save on commissions are added to their investment,” Bajaj said on BloombergQuint’s weekly series The Mutual Fund Show. That, he said, leads to huge savings in the long term.
But Tarun Birani, founder and chief executive officer of Thinkingman.in Advisors, cautioned that cost-saving may not be an enough reason for an investor to switch to direct investing.
Agreed Amol Joshi, founder of PlanRupee Investment Services. “While direct plans are better, they may not be suitable for everyone, especially new investors who require certain amount of handholding.”
Watch the full episode here:
Here are the edited excerpts from the conversation:
You are in favour of direct investing. The argument for someone to invest via the direct route in a market like India which is not well understood.
Kunal Bajaj: First we need to understand the difference between regular and direct plans. It is something which most people don’t get. Regular and direct funds are the exact same ones, run by exact same fund manager, investing in exact same stocks or bonds with one crucial difference. The difference is that in a regular plan there is regular commission being paid to somebody. In a direct plan, no commission is paid to anyone. That regular commission doesn’t come out of thin air, that regular commission comes out of the investors savings, out of his savings for family, kids, retirement. That is the difference between the two. The concept is clear. If you do think you can do it yourselves, you find a platform which allows you to invest in direct fund at a very convenient and simple manner, there is no reason that somebody should choose a regular fund and have a regular lifetime savings being drained away, something which he or she is working for.
In your experience, people investing through your platform or otherwise, have you seen some substantial change in return which could have come in?
Bajaj: The argument that most people will tell you is that small commissions don’t matter but it does matter in a significant way. In one way, you look at it and say it is 1 percent a year and not 1 percent at the time of investing. It isn’t that you bought a house and paid 1 percent to a broker. You are paying that rent of 1 percent every single year for living in that house or apartment. When you add up over a 30-year life cycle which we have by the time we start working in mid 20s and retire in mid 60s, that 1+1 will add up to your 30 percent of the savings. That is what you stand up losing when you buy a regular fund and you can earn that much more by buying a direct fund and retire much more comfortably.
Another way of looking at it is 1 percent as percentage of returns. Let’s take the argument that 1 percent doesn’t matter. 1/100 doesn’t matter. But how much do you expect to earn each year? If you expect to earn 8 percent each year, giving away 1 percent of that is giving away 1/8, which is 12.5 percent you are giving away if you return every single year. You have to see holistically the entire cost of doing the transaction of staying invested and still try and make the best decision with the guidance and platform available.
Is there an argument for paying a commission to an adviser?
Amol Joshi: When you look at numbers, it is a no brainer. All things remaining equal, direct versus regular is a no contest. Direct will win every day of the week simply because it is cheaper. I have met clients of various temperament and thought processes. Direct plans are cheaper and hence the net asset values grow faster. People think that since it is costing me more, I will get less number of units and people choose to go with regular funds. I am not stating that as an argument for regular fund. Direct versus regular should not be looked at in isolation because investors must understand what they are getting into.
How many people can afford a direct plan? Direct plans are cheaper, so everybody should be able to afford it. In India, average ticket size of a systematic investment plan is Rs 3,000. Let’s say that every person has five SIPs. So, the monthly outgo of standard Indian mutual fund investor is Rs 15,000. Per annum the investment is Rs 1.8 lakh. Any distributor, if the commission outgo is 1 percent, the customer is getting service at Rs 1,800 per annum. So, my argument is can a small investor afford a direct plan? The small and larger distribution outfits, popularly known as national distributors who have an army of individual distributors, are able to cater to these clients. Direct plans are better but not for everyone because every investor in Indian landscape can’t afford a direct plan.
What is your assessment of how the two products work for an average investor in India?
Tarun Birani: The most important part which I think is who is compensating. The compensation paid by the manufacturer or paid by the principle. You are advising how independent it is.
The good part about direct investing is, even if the adviser is giving a direct plan, since he will not make any money from the manufacturer, he has to negotiate the price from the client directly. There are RIA (registered investment adviser) models available where you can do it. The good part about that process is that it is completely independent wherein the adviser will advise based on what is good for the client. The compensation is directly decided by the client and adviser. There is no commission involved. This gives a strong edge from the suitability part. We have seen hordes of mis-selling. Due to that the direct plan offers the kind of flexibility to client where they are able to compensate directly to adviser based on value they are receiving. The compensation gives a very independent view point to client.
The argument is the selling point of direct model is that it is easily accessible to you and if you want you can save the cost. It is like if you know what is best for you but there is me who is giving you an cost-effective model.
Bajaj: India is a large country and for every truth there is a hypothesis. So, you can pinpoint a customer who had bad experience. But I can pinpoint to million customers who have terrible experiences with human advisers, including myself. People who go to bank branches asking for a tax-saving fund and walk out with an ULIP. It is much more expensive product and is not suited for them. Going to human advisers, asking for your returns and statements and adviser will say how they have done so well in last 3-5 years or whatever convenient time frame which makes them looks better. At the end of the day, we are SEBI-regulated, we are doing risk questionnaire and risk profiling and we are recommending which is the most appropriate product or savings instrument to take the customer to their goal. The goal could be Rs 25-50 lakh or Rs 1 crore. If you make the customer reach that same goal by taking less risk and not by buying a risky bond fund because you get better returns than direct plan and get him to the goal 5-7 years earlier, I don’t know why anyone has a problem. The only problem is that people cannot recognise the fact that this is in customer’s interest.
Over a 15-year period, direct or robot advisory platform is giving the customer the best suitable plan. Is the advisory firm could change if the investor is not being able to tell the customer that there is deviation here and get out of that plan?
Bajaj: There is. You don’t buy a single mutual fund and say hold it for 30 years. There is a rebalance which happens periodically. It is communicated to the investor. It is the investor consent that we look that this strategy is working out as well as we planned. We move from strategy A to B, fund A to B, within that large-cap space. The idea is to do it in very convenient manner. It is no different from a bank platform.
Joshi: There is an even bigger problem of mis-buying. The launch of online direct platform—when you open it and go for investment option, the first thing which shows is World Energy Fund. That fund is volatile and will give you nightmares. Not many Indian investors can digest it.
The second fund which is shown in the same app was small cap funds. Small- and mid-cap are down 35 percent over last six months. A first-time investor who came in because of convenience of the model is not going to come back if you make his Rs 100 a round figure of Rs 70. It is not direct versus regular, but it is who should buy direct and regular. When I say regular it means human advice. These days distributors also have their own platforms and apps. So, the reach is equally there from direct platform as regular. But who should buy is the real discussion.
How can you switch existing regular mutual fund to direct plans?
Joshi: It can be done via a paper-based request as form-based request. Log into your fund house where you have invested, create your own account and switch from your log in ID. From offline and online, you can switch from direct to regular or regular to direct.
Bajaj: You have to consider that it is a taxable event. When you move from regular fund to direct fund, it means that you are selling X and buying Y. Therefore, there might be some taxes you have to pay on it, particularly now as there is a taxation for equity mutual funds.
Joshi: Along with tax, you also have to be mindful of the exit load. Most equity has exit load of 1 percent if you are holding it for less than 1 year.
Why few funds are not bringing down costs in direct plan?
Birani: SEBI has come up with a reduction is total expense ratio, which is yet to be implemented. Recently, SEBI ensured that the commission is paid only through a trail basis to advisers. Earlier there used to be upfront costs, which used to be paid directly to advisers. Due to that, there is some reallocation in terms of expense ratio from both regular and direct plans.
Should new and inexperienced investors invest in regular plans even if they give relatively low returns?
Birani: The goal and purpose need to be very clearly defined and based on suitability of mid, long and short term, the allocation of fund needs to be done. Otherwise the experience may go bad and we cannot find happy compounding stories for them.
Bajaj: It is a bad uncle problem. Just having an adviser doesn’t make him a good adviser. If you are comfortable with an adviser, go ahead and do a regular fund. If you are not comfortable, look around a platform which you are comfortable with and in your best interest. That is the promise for what some of us are doing online.