Does investing in direct plans via RIA make sense?

Securities & Exchange Board of India (SEBI) had directed fund houses to launch a direct version of the funds in the year 2013. Therefore, when you go to buy a mutual fund, you'll find two options there, one being direct and the other being regular (via distributor). As of March 2021, assets under management (AUM) at the industry level stood at Rs 32.17 lakh crore. Direct plan contributes 45.39 per cent of the assets of the mutual fund industry of which, retail investors contribute a mere 3.35 per cent of the total industry assets, whereas HNI contributes around 7.44 per cent. Besides, corporates contribute the highest among direct plans.  

Speaking about regular plans, they contribute around 54.61 per cent of the total industry assets of which, retail investors and HNIs contribute 16.52 per cent and 19.82 per cent of the industry assets, respectively. With this, we can say that as compared to regular plans, the penetration in direct plans is still very low among retail investors and HNIs. 

The main intention of SEBI in introducing direct plans was to lower investment costs, bring in more transparency and curb mis-selling. Not to mention that the focus of direct funds was to offer knowledgeable and sophisticated investors, a low-cost product. As direct plans eliminate the role of a distributor, it sheds away any commission cost, leading to a lower expense ratio when compared with regular plans.  

As mentioned earlier, the main purpose of direct plans is not to attract retail investors. However, hiding away the reality is being marketed in quite a rosy way. Though SEBI has taken various initiatives with respect to the advertisement code and sponsorships, there is still a need to think about various loopholes attached with direct plans. 

Analysis 

In order to understand the right approach towards the regular plan and direct plan, we carried out a study wherein, we compared regular and direct plans with respect to their expense ratios. Further, we also compared the expense ratios after factoring in the percentage fees i.e. registered investment adviser (RIA) charges. According to SEBI norms, if RIA is charging on investors’ AUM, then the maximum fee that the person can charge is 2.5 per cent of the AUM. However, if he is charging a flat fee, then the maximum he can charge is Rs 1.25 lakh. 

For illustration purposes, let us assume that RIA charges 0.75 per cent on investors’ assets, irrespective of whether the investment is made in equity, debt, or hybrid. Moreover, the fees charged by RIAs are not accounted for in the calculation of the net asset value (NAV) of the fund. 

Let us take equity for instance 

If we purely look at the difference between the expense ratios of direct and plans, then, by all means, direct plans score over regular plans. Say for instance, if you invest in large-cap funds via a regular plan, then the total expense ratio (TER) is 1 per cent and the same is 0.68 per cent under the direct plan. The TER gets accounted for the fund’s NAV. However, the fees charged by the RIA on the investors’ AUM do not get accounted for in the NAV and in turn, also in the returns that they generate. One of the reasons why people get lured by direct plans is because, they are presented in such a way, where it seems that you would save x per cent, which if you compound would be more than what you will get in a regular plan. And we agree to this completely, but only when you are investing in them without an adviser. This is because if you bring in an adviser, then he would definitely charge you something. 

So, now, let us look at what is the situation when you invest in a direct plan via RIA or adviser. Here, we have assumed that on average, the adviser charges 0.75 per cent plus goods & service tax (GST), which effectively brings his fees to 0.9 per cent. 

As we can see, when you account for advisory fees, things look quite different. In fact, in 35 per cent of the cases, a regular plan seems to be cheaper than investing in a direct plan through advisers. And in 20 per cent of the cases, the difference is quite negligible. It is only in the case of a few funds where the difference is quite high. 

So, does it mean you should not invest in a direct plan? No, there’s nothing of that sort. You should consider investing in direct plans only in two cases: 1) If you are knowledgeable and sophisticated enough to invest on your own 2) You invest via fee-only RIA (subject to flat fees not being irrational). Having said that, for most of the retail investors, with annual investments less than Rs 5 lakh, investing via a mutual fund distributor still makes more sense.