This was in January 2013, when market watchdog SEBI ordered fund houses and asset management firms (AMCs) to split mutual funds into two categories. One is regular funds and the other direct funds. Investors can buy Direct Mutual Funds directly from fund houses or AMCs. In this purchase there is no agent, distributor and intermediary between the investor and the fund house.
Regular mutual funds are issued by a third party, agent or distributor. When the agent successfully locates the investor, AMC pays commission or brokerage fee to that agent. As a result, the expense ratio of regular funds will be higher than that of direct funds. However, the asset allocation, investment objective and fund manager of regular and direct funds are similar.
Benefits of direct plan of mutual fund
Buying without a third party, intermediary or an agent has a lower expense ratio in direct funds. Whereas direct funds have a lower fee ratio than regular funds. In regular funds, AMCs pay agents for their services and reimburse their costs through expense ratios. The fees are usually 1 per cent lesser than the regular plans of direct funds. While the expense ratio difference between regular and direct funds may seem minor at first but it grows exponentially.
Increase in net asset value
The Net Asset Value (NAV) of a mutual fund is the ratio of the total asset value of the fund to the number of outstanding units. NAV = (Value of the property owned) / (Outstanding Units).
A mutual fund asset may include debt instruments such as stocks, bonds, treasury bills and cash in multiple firms. Since direct funds do not charge trading fees from investors, their Net Asset Value (NAV) will be higher than regular funds.
Direct funds have a lower expense ratio as there is no brokerage or commission involved. While the difference in returns between regular and direct funds may not seem like much, it is true when investing for the long term.
According to data from Association of Mutual Funds of India, private assets are primarily distribution-driven in July 2021 as 58% of private investors’ wealth came from T30 cities and was brought through distributors.
Whereas direct investments account for 20 percent of individual assets, divided as 4% by B30 and 16% by T30. Low cost of transactions and ease of doing business are some of the reasons why investors are turning to direct plans.
Additionally, there is a paucity of high-quality distributor services, as a result of which investors are directly turning to mutual fund schemes. If this trend continues, direct plans coming from T30 cities will exceed the AUM of regular plans.
Most of the fintech mutual fund distribution platforms also do not charge commission and focus on direct schemes with lower total expense ratio as compared to regular schemes.