Direct plans: does the investor really benefit?

The best performing scheme in three years duration has returned 11.25% CAGR whereas the worst performer has given returns of -1.31%. This difference in performance is many times the difference of expense ratio between direct and regular plans (which may at best be 0.5%).

Recently there have been few articles in press comparing the returns of direct and regular plans. These articles seem to suggest that immense benefits can accrue to the investor in direct plans vis-à-vis regular plans.

With full respect to the thought process behind the above, I believe that the task is much more complex.  If we look at the challenges, we may have to bust a few myths to get a clear picture.

1. There are 45 different AMCs offering similar products across both equity and debt fund category.  Even if one looks at simple diversified equity fund category, there are large cap, mid cap, small cap, flexi cap, multi cap schemes, which can confuse the investor. Many a time, AMCs follow a popular theme through which they collect money with advertisements that can lure the common man. Does the common investor have the acumen to differentiate products and choose the one best for him?
2. Secondly, the performance of funds differ drastically even in a single scheme category. If one ranks 50 equity schemes by their returns over the last three years or five years, the difference in performance is huge. The best performing scheme in the three year duration has returned 11.25% CAGR whereas the worst performer has given returns of -1.31%. This difference in performance is many times the difference of expense ratio between direct and regular plans (which may at best be 0.5% ) It make matters tricky if the worst performing fund comes from the most trusted fund house. The story is similar in debt or balanced schemes
3. It may happen that the scheme mandate against which the money is collected from the investor can be tempered with or not followed faithfully or ignored while managing funds and chasing performance. This happens both in equity and debt schemes.  Thus, a fund which would invest in securities with accrual of income as a mandate may take a duration call to show outperformance. This works well in normal market conditions and performance of the scheme can be excellent. But In case of a negative surprise, say RBI policy, the returns can go haywire. How does the investor protect against these unforeseen situations?
4. There are different time periods to compare. Does one compare one year return or three year return or five year return? There can be no single fund which can be on top across all these time periods.  Often, the current performance suffers due to change of fund manager or merger of the AMC or merger of the scheme within the AMC; how does one protect against these events?
5. Often one is advised to look at the ratings. But there are many rating agencies with different rating parameters and most of them rate the past performance. Unless one knows what can be the future performance of the scheme based on the likely returns of the underlying sectors or stocks, how can one predict the future returns? Moreover there are examples of rating downgrades which happen after the performance drops. How does one protect against these?
6. It is very easy to claim that a certain fund gave 5000% returns or 3600% returns in 19 years.  However, how many investors have had the patience to remain with the fund for these years is a moot question.  Generally, the number may not be even in three figures. The investor can be new to the scheme; in such a case the investor is interested in point to point returns. He expects that he will get returns equivalent to five year or ten year past returns from this point of his investment.  This may or may not be true.
7. Moreover, it may not be prudent to hold the asset for such a long time, as it has been now been established that systematic asset allocation will give the best risk adjusted returns. In that case understanding the life cycle of the equity or debt investment needs acumen and sharp decision making. Asset allocation requires expertise and the hand holding by IFA can be immensely beneficial in the process.
8. Many investors get attracted to the equity market at the end of a bull run.  It is very important to spread the investments to get the best benefits. This needs a knowledgeable associate. 
9. The last and most important issue is of service. An IFA can help with compliance with KYC and requests like change of bank, change of address, lost dividend warrants, transmission, succession and redemption in addition to periodic reporting of the investments.
10. An IFA is with the investor and his family lifelong.  He represents the investor and looks after his interest holistically with full integrity and honesty.  The expense ratios of plans vary from 0.2% to 0.6% between the direct and regular plans. I think this is a small price to pay for the returns which can be generated many times more through the distributor.

The best model seems to be to have an association with an IFA who is serious about his business, thinks long term, has ethical and holistic approach, upgrades his knowledge continuously and offers unbiased service.

Bhushan Mahajan is Vice President of Pune Investment Advisors Association.

The views expressed in this article are solely of the author and do not necessarily reflect the views of Cafemutual.