How to make use of the Direct Mutual Fund Plan

Institutional clients, such as companies and banks, of fund houses have started switching to direct plans of their mutual fund (MF) investments, but retail investors haven’t yet warmed up to the idea. Effective 1 January, all asset management companies (AMCs) launched direct plans of all their open-ended MF schemes, a move which was made mandatory by the capital markets regulator, Securities and Exchange Board of India (Sebi), through a circular issued in September. 

“We have seen a widespread shift, especially by banks and financial institutions and few large corporations, from the normal plan to the direct plan,” says Akshay Gupta, chief executive officer, Peerless Funds Management Co. Ltd. “It has not yet turned out to be a mover and shaker as many had expected it to be. Besides, we still have to see the direct plan making a substantial difference to an investor’s money in order to motivate the customer to go for it,” says Manoj Nagpal, chief executive officer, Outlook Asia Capital, a Mumbai-based wealth management firm that closely tracks MFs.

It has been a fortnight since the direct plan has become a reality and the differences between the normal and direct plans are showing up, gradually. According to figures provided to us by Outlook Asia Capital, equity funds have shown a difference of about 0.58% on an annualized basis between the net asset values (NAVs) of direct and normal plans, as on 11 January. We have taken the annualized figures here as the total expense ratio (TER) figures of MF schemes are also annualized. Liquid funds have shown a far lower difference of about 0.05%, so far.

There are still some schemes that show an abnormally high difference, as high as 90% and a few other fund houses whose direct plans show a lower NAV than their normal plans. “These abnormal differences are mainly because some fund houses uploaded wrong NAVs by mistake. Since it’s a new affair, some fund officials took time to understand. But we expect such differences to get ironed out,” says a chief executive officer of a fund house, who did not want to be named. Some fund chiefs who we spoke to said that over the next six months to a year, equity funds should sport a difference of 40 to 70 basis points (bps), debt funds 10 to 30 bps and liquid funds 5 to 15 bps between the NAVs of their direct and normal plans.

Ground reality

In response to an emailed questionnaire that we sent to the top 15 fund houses (in terms of their assets under management), eight fund houses that got back to us said that they have started offering direct plans in their open-ended schemes. 

Closed-end funds and exchange-traded funds (ETFs) do not offer direct plans. “The direct plan has not been introduced for ETFs because they are listed and traded on the stock exchange. They enable investors to gain exposure to an index on a real-time basis and at a much lower cost,” says Himanshu Pandya, vice-president and head, products and communication, ICICI Prudential Asset Management Co. Ltd. Interval funds—or closed-end funds that open for subscriptions and redemptions for a limited time only—will offer direct plans from the time that they next open for subscription.

 

How to opt for them?

A direct plan is meant for those investors who wish to invest directly in a fund house without an agent’s help. Earlier, investors could invest directly, but trail fees still used to get deducted from the investment because these investors as well as those who came through agents subscribed to the MF scheme through a single NAV. The direct plan will have a separate NAV, one that is higher than the normal plan’s NAV because the former’s expense ratio is lower.

Here’s what investors—who came directly to the fund house and without a distributor’s help (direct mode) in 2012 or before—should do. 

Direct lump sum investors: Your direct mode investments made till now lie under the normal plan. Give a written request to your fund house to switch your existing units from the normal plan to the new direct plan. Download a switch request form from your fund house’s website or go to your fund house’s registrar and transfer agent or your fund house’s branch. 

Direct systematic investment plan (SIP) investors: Your existing units (from previous SIP instalments) now lie in the original or the normal plan. However, future SIP instalments (in the same SIP program) will get invested in the direct plan. If you wish to transfer your existing units to the direct plan, submit a “switch request” form to your fund house. 

Mind the capital gains tax: The reason why fund houses have not shifted your existing units (invested earlier either through lump sum or SIP) is because such shifts may attract capital gains tax. Any such shift of units from one plan to another attracts capital gains tax, if the two plans have a different NAV. Says Deepak Chatterjee, CEO, SBI Funds Management Pvt. Ltd: “A fund house cannot decide on the behalf of the investor. So if the customer wants to switch plans, we will switch after receiving the request.” If you have been holding units in an equity fund for over one year, and wish to switch now to the direct plan, then you won’t need to pay capital gains tax. 

Can your agent submit a direct plan? No. If your agent submits your application form, where you have marked “direct”, the fund house will de-recognize your agent’s code. In other words, your agent will not get access to your records with the fund house where you invested and will, therefore, not be able to provide any service on that folio.

Does a switch attract exit loads?

It depends on which plan you switch from, into which plan and when. If you shift your investment made earlier through the direct mode, to the new direct plan, then you don’t need to pay an exit load. Note that although exit loads have been waived for switches made from direct mode to direct plan, the exit load validity still remains on complete withdrawal. 

Here’s what it means: Say, you invested in your equity scheme on 1 July. Assume also, at that time, it carried an exit load of 1% if units get withdrawn within year. On 1 January when the direct plan came into being, your units continued to remain in the normal plan and you decide to switch to the direct plan. Such a switch will not carry an exit load at this point. But the original one-year condition of exit load on withdrawals continues. So if you withdraw your units on, say, 31 March 2013 (from the direct plan; since you are now invested in it, after you switched on 1 January) you will need to pay an exit load. Why? Because when you had originally invested in July 2012, the exit load clause stipulated that you stay invested for a year.

However, if you had invested through a distributor before and would now like to switch to the direct plan, you will need to pay an exit load at the time of switch. “This is being done to protect the interest of the distributor. The MF industry felt it is not fair on distributors if investors sought their advice and invested in MFs, only to shift to the direct plan now and deny the distributors, their rightful trail commission,” says the head of client servicing of a foreign fund house, who did not want to be named because he is not the fund’s official spokesperson.