Here, the investor calls an agent and asks for the ‘best’ mutual fund to invest. The agent advises a fund which has highest commission (i.e. best for the agent) and the deal is done. The investor in this case is acting like he has got a target of mutual fund investment (instead of the agent). He does not go into details of the fund. Since the client is not knowledgeable, agent too feels boring to justify any product and hence pitches for the highest commission.
Another case is when investor calls an agent and tells him that he has X amount to invest and would need Y amount by Z number of years. The agent can then take a calculated call depending upon the rate of interest required and can suggest suitable mutual fund. In this case, the agent can propose any CAGR value to justify the fund proposed or even show the CAGR value only for a certain period of time and win the deal.
In the last case, the agent understands the goals, the surplus amount, spending pattern and other such things. He then comes up with a fund name. The client studies this fund and if suited finally gives his approval and then the deal gets done.
Direct mutual fund plans:
In first case, the investor first understands about his own risk taking ability depending on the loans, EMIs, spending pattern, earning capacity, etc. He then researches about various mutual fund AMCs in the market and the funds offered by them. He then correlates the mutual fund schemes with his goals (duration and amount required). Once the short listing process is done, he goes ‘directly’ to the AMC office or their website. Creates a user id/ password and starts the investment.
Investor discusses his goals, risks, liabilities and earning capacity with a financial planner. They arrive upon a time frame for goals and whether they are achievable. Then they shortlist the AMC and subsequently the scheme. The investor pays the planner his fees for the advice and guidance. The investor then visits the AMC office or website and starts investment ‘directly’.
Investor going to ICICI Direct securities office for buying mutual fund: Nothing wrong with this. However, the investor has to understand that ICICI Direct securities office is the agent in this case which facilitates the buying of mutual fund units from the ICICI AMC.
Investor going to SBI bank to buy SBI mutual fund scheme: Again, nothing wrong with this. However, people think that this is direct investment. Here, the bank acts as an agent to facilitate the trade between the investor and the SBI AMC.
Now, that we are clear about the difference between the 2 models, let us go further.
Let us first understand how this debate has cropped up and should an investor pay any heed to this debate:
In 2012, SEBI mandated all the AMCs to come up with direct plan effective 1st Jan 2013. This direct plan is the one which would be directly bought from the AMC and not via distributor. Agent has to be kept out of the transaction. This gave rise to the 2 different models that we just saw about. Looking at the pros and cons of each model would help us understand if we need to pay any heed towards this debate.
Pros: Theoretically, these mutual funds are bought by investors without any involvement of agents. Hence, the AMC saves loads of money, which otherwise would have gone to agents via the trail commissions. Imagine a crude equation like this:
NAV movement is not only associated with the market movement but is also with the expenses or overheads of the AMC.
On the expenses: marketing, sales and salaries are covered. These expenses are not directly proportional to the units sold. These are fixed expenses and would be incurred irrespective of the sale. However, agent commissions are directly related to the units sold and are huge percentage of overall expenses. Hence, more the agent’s trade more is his commission (rightly so). This in turn reduces the net positive movement of the NAV.
When AMC eliminates this factor, it gets a great boost for the net positive movement of the NAV. This is the reason that it is theoretically claimed that direct investment will generate more profit for the investors (as compared to the regular plans).
Example: NAV of Franklin India Blue-chip
Normal/Regular: 344.95 (Growth. As on 17th June)
Direct plan: 351.75 (Growth. As on 17th June)
Notice a good 1.97% of the increase. Here it can be safely assumed that in the long run of say 10-15 years, this 1.97% would have a huge impact on the overall portfolio.
Cons: Investor has to do all the research himself. The investor has to maintain the login credentials of each AMC.
The investor has to keep a track of all the investments individually (can be done via a free software like Perfios).
The investor has to review all the schemes periodically himself. However, he can choose to pay a fee to the financial planner for the review.
As we can see here, the net profit is reduced by each of the component i.e. Marketing expenses, employee salaries and agent commission. Agent commission being largest expense for any AMC. Hence, more the agent commission less would be the net profit.
Now, let us move to the Regular plans:
The cons are obviously higher expense ratio and reduced gains for an investor in the long run.
The agent can keep a track of your entire folio using his ARN (AMFI Registration Number). (Counter wise, can you really trust another person to review and take decisions on your behalf for your folio? I think, no).
The agent can and will do all the paper work for you.
You do not have to visit the AMC office, even once.
Major advantage as compared to the direct plan is discussed in further paragraphs.
What should you really choose?
The tech savvy and the dedicated investor need not worry about all these things. He can/must/should focus on the direct investment model. The already dedicated investor needs no other motivation than seeing his scheme performing better than regular plans. They are focused/dedicated enough to take some time out of their weekend schedule and visit the AMCs for initial KYC. Once you KYC is done, you can invest in almost any AMCs without any paperwork. Most AMCs these days offer online investments if your KYC is verified (with few exceptions).
Now, what should an average investor do? The last pro of regular plan is this: psychological advantage. An average investor will not take the pain of understanding the SID of mutual fund, the nature of the mutual fund scheme (i.e. large cap, midcap), sector funds, etc. All these words are alien to average investor. They get bored of even thinking to go to AMC office and doing all the paper work or even KYC. The thought of getting out of the house on weekend is discouraging to them. All the financial jargons intimidate them. Hence, they keep on procrastinating all the year. At the end of the year, they buy tax saving craps. This too is out of convenience. The tax filing guy doubles up as the mutual fund distributer of life insurance agent. He simply asks to sign few papers and announces that the tax liability is reduced.
This psychological hindrance can be avoided if an average investor decides to go for an agent for mutual fund in the first place. For average investors, the high expense ratio is justified.