InvestorQ : Why have mutual fund Direct Plans not fully taken off despite it being 7 years since they were first permitted in 2013?
Tisha Malhotra made post

Why have mutual fund Direct Plans not fully taken off despite it being 7 years since they were first permitted in 2013?

user profile image
Moii Chavate answered.
7 months ago

The response to Direct Plans as compared to Regular plans still leaves a lot to be desired. Less than 12% of customers have shifted to Direct Plans. Ideally they should have taken off in a big way because it does make a big difference. For example, in an equity fund, the average difference between a Direct Plan and Regular Plan ranges from 0.6% to 0.8% annualized. That means, over a period of 10 years, the cost differential is nearly 7-9%. When you see that as a percentage of the corpus, it can be quite large. In fact, even investors like Buffett have appreciated the concept of lower costs in enhancing returns to mutual fund holders. Then why is it that Direct Plans have not taken off in India.

Let us look at some key reasons why direct plans have not taken off in India

· Lack of awareness and understanding is the biggest reason for the slow spread of Direct Plans. Most mutual fund investors are passive investors or they are first time investors. They still do not understand the nuances of Direct Plans versus regular plans. Secondly, there was a lot of flawed understanding of these plans in the past. For example, investors believed that Direct Plans will involve zero cost. That was obviously not the case as they save only on distribution costs. Other costs like management fees, statutory charges and registry fees are still billed to Direct Plans.

· Secondly, AMCs have not been too keen to push this plan to customers. Mutual funds are more comfortable with an advisory intermediation since it ensures that investors are advised before taking mutual fund investment decisions. Also, pushing Direct Plans too aggressively will mean that the AMCS may be rubbing their core distributors the wrong way. AMCs still rely on distributors and feet-on-street to sell the idea of mutual funds to customers.

· Thirdly, the cost advantage is gradually diminishing. The cost advantage was nearly 1% in the beginning. Across the board the gap is falling to around 0.5 to 0.7%, which is not really attracting the investors. This compression of the gap has been seen across equity and debt funds and across various AMCs.

· Fourthly, most customers still prefer to be supported and hand-held by brokers and advisors. Mutual funds are a complex mass of investment ideas and separating the wheat from the chaff is not everyone’s cup of tea. That is why investors, even HNIs, are more than willing to pay that little bit extra so they can get reliable and actionable advice on mutual fund investing.

· In the recent past there have been instances where the Dividend option of a Regular Plan has received higher dividends than the Dividend option of a Direct Plan. Mutual funds are aware of this and so is SEBI. The reason is more technical in nature. The dividends of a scheme are based on the Unit Premium Reserve (UPR). Since Direct Plans have been around only since 2013, the Regular Plans are in a position to pay higher dividends to their unit holders. This takes away the cost benefit that the Direct Plan offers.

Direct Plans are a great idea because as other markets have discovered, low cost is a good idea of cutting down on cost and enhancing returns. But the Indian market will have to mature a little more and more importantly the Direct Plans will have to become more transparent and meaningful in the long run before they really take off in a big way.