Direct vs Regular Mutual Fund

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Marketopedia / Importance of Personal Finance / Direct vs Regular Mutual Fund

As a child in Bangalore during the 90s, Vadilal, Dollops, Kwality and Joy Ice Cream were familiar brands. The one I particularly liked was Joy because the ice cream factory was only half a kilometre from my house.

The small factory had a store out front, where my parents often sent me to pick up chocolate-coated ice cream bars. For just Rs.14/-, we got the same treat that would usually cost Rs.18/- at Anu stores, which is still around a kilometre away! Even if they weren’t treating us to ice cream, they were pleased with the amount of money they were able to save. Everyone was satisfied in the end!

Good old days 🙂

What do you suppose is the reason the factory was selling the ice cream for Rs.14 while Anu stores charged Rs.18?

Well, Anu stores needed an incentive to sell Joy ice cream, so the company marked up the price to include this. Therefore, the choco bar was sold at Rs.18/- – providing a reason for owners to stock it.

At the factor’s store, there is no motivation for Joy Ice Cream since the organisation profits equally from offering their item straightforwardly to the client at Rs.14/-.

I suppose this is a simple business model to understand.

Same goes with Mutual Funds.

You can choose to buy Mutual Funds in two ways –

  •       From the AMC directly
  •       Via a distributor

When you purchase a mutual fund straight from the AMC, it is known as a ‘Direct’ transaction. This is similar to buying ice cream from the manufacturer’s own retail outlet.

On the other hand, investing in a mutual fund through a distributor is similar to obtaining your ice cream from Anu stores.

In order to motivate distributors to sell regular mutual funds, AMCs add a markup to the TER, converting it into additional revenue. Consequently, when looking at any specific fund, the TER of the regular version will always be higher than that of the direct version.

This brings us to a noteworthy point – each mutual fund scheme comes in two plans.

  •       Direct Plan
  •       Regular Plan

The snapshot below, taken from the HDFC AMC website, reveals that while all else remains constant, the TER has shifted.

Looking at the HDFC Top 100 Fund (Growth), two variants can be seen: the direct plan, which is the first in this list and clearly specified as such, and the regular plan, which, while not explicitly stated by the AMC, is implied.

The TER for both these funds is different. Here is the snapshot –

The TER for Direct stands at 1.28%, compared to the Regular option’s 1.78%. The extra 0.5% in the latter is to ensure the distributor receives proper pay for marketing the Mutual Fund product.

It is imperative to comprehend that you, the investor, are paying the TER to the AMC and distributor.

When you buy directly from AMC, you can avoid distributor commission and thus enjoy lower TER. Lower TER means higher returns for you.

At this point, it is clear that the TER for regular funds is higher than their  direct counterparts. Fund management, strategy, portfolio makeup, risk profile and other factors are the same; however, the TER or expense ratio differs.

The TER of a mutual fund will vary depending on the AMC and its funds. This incentivizes mutual fund agents or distributors to offer these funds, meaning they may be more likely to suggest them to their clients. You may have questions about this;

  •       Who are these ‘MF agents or distributors’ trying to convince you to buy regular plans?
  •       Why would anyone opt for regular funds given that these have higher TER?
  •       If the two funds are alike, why is there a discrepancy in the NAV of the direct fund and that of the regular fund (as per the snapshot presented)?

MF agents could be your local bank manager, your annoying Sunday morning visitor trying to peddle a ‘financial scheme’, or even an online website. At such places, you can purchase mutual funds on your own.

No matter who the distributor is, it is important to be mindful that when purchasing a standard MF, you will be paying a higher TER.

Would it be more sensible to invest in a plan with a lower TER, regardless of the cost?

Well, no.

If you lack knowledge of Mutual fund investments, it pays to speak with an advisor. This professional can provide insight, track markets, monitor MF performance and rebalance as necessary. As such, it is only right to reward the advisor for their work by purchasing a regular Mutual Fund.

If you have an understanding of Mutual funds, then opt for a direct fund to help save on costs; it would be the most suitable choice.

This should shed some light on what these distributors are and why someone should or shouldn’t go for regular funds.

The most asked query is possibly why the NAV of direct funds comes out higher than that of ordinary funds.

Confusion arises from the NAV of the regular fund being cheaper, so why spend more on the direct fund when its NAV is higher?

For example, look at the NAVs for HDFC Top 100 fund –

  •       Direct plan NAV is 460.5
  •       Regular plan NAV is 438.4

The difference between the two funds is almost Rs.22/- per unit, meaning it’s understandable to opt for the cheaper one.

The issue lies in how one looks at the NAV. If perceived as a cost of accessing the mutual fund, then the NAV of a regular plan appears more pocket-friendly and therefore may seem like an intelligent choice to opt for it.

It is essential for you to look past the NAV as an asset price, and rather think of it as a value of an asset. Consequently, a regular plan can be less rewarding when compared to the direct plan. Understandably, the NAV means ‘Net Asset Value’ instead of ‘Net Asset Price’. I trust that this subtle difference made sense to you.

Consider NAV as the current value of your obtained asset.

In the subsequent chapter, we will further explore a few mutual fund metrics.

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