Since their introduction in January 2013, direct plans have made major inroads. The main reason for this, of course, is the low expense ratio. Since investors approach a mutual fund directly, no commission is paid to distributors and that explains why the expense ratio of a direct plan is lower than that of a regular plan. It also means returns will be higher for direct plans as against regular plans as the portfolio is common.
Many big corporates were used to dealing directly with the fund houses (even before the introduction of direct plans) and they were the first to switch sides for better returns. Now, the shift of retail investors to direct plans is also gaining momentum. As per the latest data on assets under management (AUM) a, 14% of the individual AUM in top 15 cities comes through direct route. The share of individual AUM in other cities, popularly known as B-15 cities, is at 9%.
Though the expense ratio of direct plans is less, it should have been lesser. A closer look at the expense difference between direct and regular plans will reveal this. For example, the expense ratio difference between direct and regular plans is between 50 bps and 75 bps for most equity schemes. Why is the difference this low when it is common knowledge that mutual funds pay between 0.75% and 1.25% to distributors as commission? This commission varies from small distributors to national distributors.
How do mutual funds manage this? Let us take a closer look at all expense heads for the answer. The brokerage on buying and selling of securities, operational expenses like custodian charges, etc, are shared between direct and regular plans. The distributor commission is charged only to regular plans (to make this difference clearer, regular plans should be renamed as distributor plans).
AMC (asset management company) fee is charged to both plans equally and this fee is the bone of contention now. The salaries of employees, maintenance of offices, etc, come from this. In addition to that, AMCs also use part of this fee to pay commission to the distributors. This action doesn’t make any difference to regular plan investors because this expense would have been charged as distributor commission. However, why should the AMC fee collected from direct plans also be used for paying commission to distributors?
