The surge in the assets under management of mutual funds — now at a record high of over Rs 19 lakh crore — suggests investors have recognised their many virtues, both as an investment avenue and an investment planning tool. While the bulk of these assets is from institutional investors, retail participation has also risen over the years. In the past three years alone, individual investors have pumped in more than Rs 3 lakh crore into various schemes, the bulk in equity. This is a huge change for a country obsessed with bank fixed deposits (FDs) and other traditional fixed-income instruments.
Perhaps the biggest benefit of mutual funds is the opportunity to earn market-linked returns based on the investor’s risk return profile and investment horizon, which is not possible in case of most traditional products. Then, there are other benefits as well, such as professional management, variety and flexibility.
Broadly, there are two routes available for investment in mutual funds. Investors with a good understanding of their investment needs and decisions can opt for direct plans of mutual fund schemes, while others can go through distributors for a seamless experience. Either way, mutual funds are a good long-term vehicle for wealth creation.
Direct plans provide an edge, but variation and choice requires research and understanding
Prior to January 2013, there was a single plan structure for all investors. Then, the Securities and Exchange Board of India mandated fund houses to offer two type of plans: 1) direct plans for investors who want to directly purchase mutual funds from fund houses rather than going through the distribution channel, and 2) regular plans, or the original format of schemes, sold through the distribution channel involving national distributors, banks, independent financial advisors, aggregators and digital channels.
The expense ratio in direct plans is lower than in regular plans. As a result of the cost saving on distribution fee, the net asset value (NAV) is higher, thus generating higher spread in returns (see table).
There is, however, variation within the funds in terms of spreads between direct and regular plans. Also, a higher or lower spread does not denote better or worse performance. A CRISIL analysis shows that in the equity funds category, 38 per cent funds with higher-than-average spreads have underperformed the category average, while 23 per cent with lower spreads have outperformed the category average during four year period.
Further, while the returns tend to be better than on regular plans, direct plans are the preserve of institutional investors, who typically have their own research teams in place to take investment decisions. Individual investors, despite having eons of data at their fingertips, may find it difficult to select the right fund from a universe of 2000+ schemes. Besides, there are other aspects to take care of, from knowing the tax implications of investments and carrying out the documentation and other operational work, to consolidating investments and keeping a tab on it.
This is borne out by the fact that individual participation in these plans has just reached 15 per cent in the past four years even as the share of direct plans in the industry assets has shot over 40 per cent. Therefore, only well-informed investors, who have the wherewithal to deep-dive, research and identify funds suited to their risk-return profile and goals should take the direct plans route. Most individual investors lack the time or knowledge to make and track their investments. These services are provided by a distributor in case of regular plans, and may be worthwhile despite the cost to be borne. This is especially true of beyond top 15 cities, where financial literacy is lower. Such investors should ideally go through distributors. Despite the growth in the industry AUM, mutual fund penetration in India remains low. For the industry to reach the global level, it needs to grow both in terms of size and penetration – the latter being especially important from the point of view of financial inclusion. And this would require growth through both regular and direct plans.
(The writer is director of funds and fixed income research at Crisil)