It has been over 6 years since the direct plans of the mutual fund schemes were launched in January 2013. It is a good time to compare the performance between the direct and regular plans of the MF schemes.
To recap, each MF scheme has a direct and regular plan variant. The portfolio and the fund manager are the same in both the variants. The difference is in the payment of commissions. Direct mutual funds do not pay any commissions. Regular (variant) of MF schemes pay commissions to distributors. Lower costs in direct plans translate to better returns.
While this exercise can be made every exhaustive, I think we can compare the performance of direct and regular variants of a single scheme to drive home the point. I picked one of the most popular equity funds in the space and see how its direct and regular plan variants have done. I have picked up Mirae Emerging Bluechip Fund for comparison. Note: This is not a recommendation to invest in this fund.
You can do this exercise for your MF scheme and see the difference.
Direct plan gives better returns and this trend will continue
You invest Rs 10 lacs each in direct and regular variants of Mirae Asset Emerging Bluechip fund in January 2013.
With the regular plan, you have Rs 36.17 lacs. With the direct plan, you have Rs. 38.73 lacs, 7.06% more than the regular plan variant.
The returns in equity markets have been good since Jan 2013. This fund has done exceptionally well. While the performance has been great even for the regular plan variant, direct plan variant has done better.
Because the portfolio (gross) returns are the same for both regular and direct plans. The direct plan inches ahead because of lower costs. While this cost difference may look small (0.5-1.0%), it makes substantial difference over the long term.
Remember, both the direct plan and the regular plan variant on Jan 2, 2014: Rs 14.105
As on June 19, 2020,
The NAV for the regular plan is 51.024. CAGR of 18.80% p.a.
The NAV for the direct plan is 54.629. CAGR of 19.90% p.a.
You can see that the NAV for the direct plan has grown faster.
And this is a mathematical construct. This gap between the NAV of the direct plan and the regular plan will continue to widen every month.
This happens because everything is the same in a regular plan and the direct plan except for the costs. The portfolio is the same. The fund manager is the same. The only difference is that the direct mutual funds do not have to pay any commissions. Regular mutual funds must pay commissions. The current expense ratio (May 31, 2020) for the direct plan is 0.86% p.a. and the regular plan is 1.87% p.a. Difference is 1.01% p.a. (in line with the difference between CAGRs) Note that the expense ratio (and the difference between the expense ratios of regular and direct scheme) keeps changing.
A common misconception is that the direct plans have higher NAVs. Hence, you will get a lesser number of units (than regular plans). Yes, that’s right. But that is immaterial. What matters is which variant will give better returns going forward. And it will be the direct plan. I have addressed this question in this post. In fact, the reason why the direct plan has a higher NAV is that it has given better returns. Remember, both the direct and regular variants started at the same NAV in January 2013.
SIP does not paint a different picture
I plot the data for the SIP of Rs 25,000 on the 1st of each month. 90 installments have gone in until now. Total investment of Rs 22.5 lacs.
By investing in the regular plan of this fund, you have lost out Rs 1.64 lacs. Or you would have Rs 1.64 lacs more by running the SIP in the direct plan compared to the regular plan. IRR of 14.82% for the direct plan vs 13.72% for the regular plan.
No surprise here.
As mentioned earlier, this difference (at least in percentage terms) will continue to grow.
The results (SIP or lumpsum) will vary across scheme categories, schemes and AMCs. Debt MF schemes are likely to pay lower commissions compared to equity funds. Within the equity space, actively managed equity funds are likely to pay higher commissions. Passive index funds are likely to pay lower commissions. You can check the difference for your funds.
What should you do?
If you are a Do-it-yourself investor, then it is criminal to invest in regular plans. You incur an additional cost for nothing. Now, it is not a question of operational convenience either (for most of us). They are many platforms such as MFU, Kuvera, PayTM Money, etc that allow you to invest in direct mutual funds from multiple AMCs from a single interface.
If you seek professional assistance, you need to make a choice.
You can work with a distributor and invest in regular plans. You pay nothing to the distributor. The AMC pays the distributor on your behalf and adjusts the payment within the NAV. Therefore, even though you do not write a cheque, you still pay for the advice and operational convenience. With regular plans, there is always potential for conflict of interest. The intermediary might prefer to push products that offer higher commissions. Your interests may take a backseat. Not necessarily though. There are many distributors who are doing a very fine job.
Alternatively, you can work with a SEBI registered investment advisor (RIA), pay for the advice and invest in direct plans. SEBI RIAs can have different work and compensation models. Some use a fixed-fee model, some use a percentage of asset based and others a blend of the two. There is no right or wrong model. The compensation should be fair to both the investor and the adviser.
If you are a new investor and just want a quick way to get started, you may want to work with advisers who work on 5-hour per client approach. Their approach might also be cost-effective for you.
If you are a serious investor, want a customized solution for your hard-earned money and be more involved in the decision-making, you might want to work with RIAs who prefer a more consultative process and spend more time with the investors.