Direct or Regular? – A Detailed View

Earn ₹ 25 Lakhs more in 25 years. Get 1% extra returns on your investments. “No Hidden Charges” if you invest through us. Why pay commission to agents? Do these lines ring a bell? We all have been seeing many media campaigns like these in last couple of years. A lot of social media Finfluencers (that’s how they term the financial influencers) tell that investing in direct plans of Mutual Funds will earn more returns than the regular plans. For a quick understanding – Regular Plans (existent since the start of MF industry) are ones where an investment service provider/Mutual Fund Distributor earns a commission/brokerage from the Mutual Fund companies for the services offered. Direct Plans are ones where an investment adviser is not paid any commission/brokerage by the Mutual Fund Companies, instead, the investor directly pays a fee for the advisory services availed. Investors having the time, resources, and expertise to manage their own investments also opt for direct plans. 

We have been in Mutual Fund Distribution business since 2009 and we earn brokerage from the mutual fund companies. As we are writing this, as on today, 2100 clients have invested their trust in us and have collectively invested over 400 crores through us. We are not authoring this article to arrive at a judgement on regular vis-à-vis direct plans or who is better between a Mutual Fund Distributor (also referred as MFD) and a Registered Investment Adviser (referred as RIA). Our intention is just to give a holistic understanding of both the models with a practical long-term perspective. 

Before we go to the topic, we feel it is necessary to give some background and thread this into a meaningful information. The Securities and Exchanges Board of India (SEBI) regulates the capital market in India and is one of the most astute regulators across the globe. SEBI is committed on safeguarding the investors’ interest and proactively takes measures to avoid any kind of catastrophes in capital market. In the Mutual Fund industry, the Mutual Fund Companies, Fund Managers, Distributors (directly/indirectly) etc., are all regulated by SEBI. SEBI’s decision to abolish the entry load for the mutual funds in 2009 sounded like a setback for the industry at that time. But in hindsight, it clearly manifests their foresight and intentions of keeping the investors’ interest first. Even the recent measures on categorisation of mutual funds were done to bring clarity and transparency for investors. This also made the role of the Mutual Fund Distributors simpler. If an MFD matches the suitable products with the investments needs of an investor and adheres to asset allocation, the rest is well taken care by the qualified Mutual Fund Managers.

As per SEBI Regulations, Mutual Funds are permitted to charge certain operating expenses for managing a scheme (which includes expenses for sales, marketing, administrative, management, audit etc.). All such costs for running and managing a mutual fund scheme are collectively referred to as ‘Total Expense Ratio’ (TER). The TER is calculated as a percentage of the Scheme’s average Net Asset Value (NAV) and the daily NAV of a mutual fund is disclosed after deducting the expenses. Each mutual fund scheme has two NAVs – one for Regular Scheme and other for Direct Scheme.

Now that you understand TER, let us go a little deeper into this. In the interest of investors, SEBI has also provided a framework for the total expense ratio that all mutual funds need to adhere to. This framework defines the permissible percentage of TER for each of the mutual funds based on the categorisation (Equity, Debt etc.) and the Asset Under Management (AUM) which is quantum of money that a mutual fund scheme manages. The framework also dictates that the percentage of the TER should keep decreasing as the fund size grows bigger. In other words, higher the fund size, lower will be the expense ratio and in turn lower will be the commission/brokerage paid to the distributors. You can access these details by clicking here.

As far as transparency is concerned SEBI has mandated to disclose the brokerage income to the investors. We adhere to this requirement and the same is made publicly available on our website (check here). Over and above this, every investor also gets a Common Account Statement (CAS) periodically from the Mutual Fund Registrars (CAMS/K-Fintech) which carries the details of the total brokerage paid to his/her Mutual Fund distributor. Doesn’t this void the argument of hidden charges in regular schemes? 

Let us see this from the perspective of a business also. It is obvious that a business needs to meet its operating expenses and cannot sustain without earning a decent margin. Profit margin is the incentive for which an entrepreneur takes the business risk. In a cost-centric country like India, any business, particularly in a service industry like ours, cannot enjoy irrational margins in today’s age. It is a known fact that mutual funds are effective and tax efficient for creating a passive income, have commendable performance history, least/nil scams and are highly regulated. With increasing financial awareness and higher investible surplus, it is a no-brainer that the mutual fund industry will continue to grow leaps and bounds in the coming years. Which means the AUM of the funds will keep growing and as a result, the expense ratio will keep reducing. The cost coming down is obviously beneficial for the investors. And even a MFD will be able to sustain this lower brokerage provided he puts efforts and grows his client base over time.

Now one might argue that with a 7 – 8 years’ time, the gap between the performance of regular and direct scheme might get unignorably high as 5 – 6%. But practically the gap might not be that significant if one considers the fees paid to RIA over the years and yes, also 18% GST on the fees. And we should be cognizant of the fact that the regulation permits upward revision of the yearly advisory fees. This means it might require an investor to negotiate the advisory fees from time to time to ensure the advisory cost doesn’t increase with the growth of his/her assets under advice. 

With all these points, our intention is to counter the argument that MFD earn supernatural commissions at investors’ cost. And now we made it clear that there are no hidden charges in regular mutual fund schemes as propagated in the media by a section of service providers. For an investor, his/her job, profession, or business is quite demanding, and the time and efforts spent there has a direct impact on his/her primary source of wealth. We are living in a world with lots of data that will persuade us to build opinions and lead our decisions on money matters into a dilemma. It is prudent to involve a trustworthy partner committed to keep our family’s financial wellbeing as the primary objective to get the best outcome for our hard-earned money. Cost is important but it should not be an impetus, as a dedicated financial partner will add value to the overall financial wellbeing in the long run. One should always remember the adage – “There is no such thing as free lunch”.

Shreedhara R Bhat

Shreedhara is the Founder & Director of Ara Financial Services Pvt. Ltd. He has an experience of over 2 decades in Financial Service Industry with majority of it in guiding individuals and institutions on their investments requirements.