Direct vs Regular
You may have come across this term before for a particular scheme e.g. Axis Bluechip Fund Direct Plan and Axis Bluechip Fund Regular Plan. While the scheme is the same and the underlying securities are the same there is quite a difference between the two.
Simply put, a Direct plan is what you buy directly from the mutual fund company (usually from their own website). Whereas a Regular plan is what you buy through an advisor, broker, or distributor (intermediary) such as your bank. In a regular plan, the mutual fund company pays a commission to the intermediary. This is then recovered as an expense from the plan. In mutual funds speak, the expense ratio is higher for a regular plan.
As we have learned all else being equal, a higher expense ratio leads to a lower return. Hence, the returns of a Direct Plan are higher than that of a Regular Plan.
Before you opt for a Direct Plan based solely on lower expense ratios, it is important to consider the several advantages a Regular Plan provides that could make them more suitable for you. The biggest benefit that a Regular Plan offers is convenience of buying through an intermediary through a single channel and not having to visit multiple fund websites. Also, when buying through a financial advisor or distributor, you get access to their recommendations and advice that will help you construct a portfolio specifically catered to your needs as well as resources such as fund scheme reports etc.
Active vs Passive
Put simply passive funds are funds which simply replicate a market index e.g. The Nifty50. There is no active decision making here and the portfolio is simply rebalanced daily to match the Index composition. Because there is no active decision making, the fee structure of a Passive fund is much lower than that of an active fund.
An Active Fund as the name suggests, involves active decision making on the fund manager’s behalf. Here, the goal is to outperform a benchmark index i.e. to generate a positive alpha. The fund manager and analysts use their knowledge and experience to buy those securities that can generate maximum returns for their fund. An important point to note here is active funds do not always generate a positive alpha i.e. they do not always outperform their underlying index so their alpha cannot be taken as a guarantee. In fact, the number of funds generating positive alpha has been consistently decreasing over the past few years.
When constructing a portfolio, you may choose to opt for a mix of active and passive funds or simply only active or passive. Here, the key consideration should not simply be the lower fee structure, but rather the quality of the funds’ performance. While past returns do not guarantee future returns they are a good indicator of the quality of fund management. If a fund has a history of generating alpha along with stability of returns, then it is a good gauge of its quality.
A Beginner’s Guide to Mutual Funds and Why You Should Consider Them
Different Types of Mutual Funds and What They Mean for Investor
Mutual Funds & Terms associated with it
A Few Good Practices to Keep in Mind
If you do decide to begin investing in Mutual Funds, here are a few good practices you may want to inculcate. I have learnt to form several of these through personal experience (often through painful ones at that). These are not complex by any means or even great secrets, but just good habits that if constantly applied can help you achieve your goals much better.
So, let’s get into them
Spend Some Time on Research
It is always a good idea to do your own research before making an investment decision. Investors often buy a scheme simply on the basis of returns over a single period taken in isolation. Rather, a much better and safer way to invest is by using tools such as fact sheets or websites such Value Research to check the historical performance of the scheme as well as compare it with the other top schemes in the category.
The research here does not have to be all that time consuming. Most fact sheets have at most 2 or 3 pages on a particular scheme providing you with a quick but comprehensive overview while tools like Value Research allow you to easily compare a scheme’s most recent as well as historical performance with its peers. The time needed to assess MF schemes is a lot less compared to researching individual stocks. Thus there is no reason for you not to put in that little extra effort and save yourself a lot of future headaches.
Also monitor your portfolio at least once a month so that you are aware of any sharp movements in the holdings. It is also a good idea to maintain a journal of your thoughts and observations during your review process. These notes will come extremely handy when making any future purchase or selling decisions.
Keep it Simple
I have often noticed several people sometimes holding upwards of 10 – 12 schemes in an effort to diversify their portfolios. In my opinion, this is a pointless and simply counterproductive exercise.
There is simply no real benefit to be gained by spreading your portfolio across 10 schemes and hoping to minimise your risk and maximise returns (especially when unlike a single stock, mutual funds hold multiple securities in their portfolio which are likely to overlap in different schemes). I think you would be much better served in the long run by narrowing it down to 3 – 4 schemes (and maybe up to 6) that meet your criteria. This way you can achieve diversification through a mix of schemes such as Large and Small Cap thus reducing risk and still have a meaningful exposure to each holding to take advantage if any one scheme outperforms.
There is also nothing wrong in allocating capital to 2 different schemes in the same category e.g. 2 Large Cap Funds. If doing this though just check from their latest Fact Sheets if their underlying holdings are the same. If yes, then you may as well just stick with one of them.
Our next and final article shall speak about a few more good practices such as avoiding excess speculation and when to reallocate or exit.
Read also:
A Beginner’s Guide to Mutual Funds and Why You Should Consider Them
Different Types of Mutual Funds and What They Mean for Investor
Mutual Funds & Terms associated with it