Ratings of Direct plans Mutual Funds are lower than that of Regular plans, why?

Do you know that there are many mutual funds whose direct plans have a lower rating than that of Regular plans? Does this defy logic?

For instance, the BNP Paribas Multi Cap fund is a 4-star fund if you look at the direct plan. However, the regular plan seems to have a 5-star rating. Why is there a difference?

Ratings of Direct plans Mutual Funds are lower than that of Regular plans, why?

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Ratings are usually based on the performance of the fund. However, for the rating of regular plans, the comparison for rating will be based on regular plans and for the rating of direct plans, the comparison will be with other direct plans. So, if there are better direct plans within a fund category, the rating for the direct plan of a scheme will be lower than that of the regular one. Before you understand that, you need to know how direct and regular plans work. 


The launch of direct plans

Way back in 2012, the Securities Exchange Board of India (SEBI) had come out with many measures which included the introduction of direct plans. This was to cut the costs of investing in mutual funds. Every mutual fund was told to have two options of the same mutual funds – one regular and one direct. The funds are managed by the same fund manager and the fund portfolio is the same too. Scheme features such as the fund’s investment objective, asset allocation pattern, risks, investment strategy, terms and conditions such as the exit load structure are the same for both the funds.The main difference between these two is the cost of investment. In case of a regular fund, you pay a commission to the broker/agent as a distribution fee which is added to your investment costs. In case of a direct plan, no such fee/commission is paid. So, the cost of investment is lesser.

There are some other dissimilarities too.

The differences

As you might know now, regular and direct plans are variants of the same scheme offered by fund houses. They prominently differ in some parameters.

Distribution – You can buy a regular plan of a mutual fund through various routes such as brokers, Registrar and Transfer Agents (RTA) such as CAMS,market intermediaries, through the fund house as well as through offices of the fund house. However, direct plans can be bought only using platforms such as RTAs, authorized local representatives of the fund house and Registered Investment Advisors (RIA). 

Expense Ratio– Regular plans of mutual funds have higher expense ratios compared to direct plans. Direct plans don’t incur any agent commissions or distributor fees that are payable to brokers/distribution agents of the regular plans. So, the returns offered by the direct mutual fund schemes are usually higher than that of regular plans. 

When you invest in a regular mutual fund plan, the mutual fund houses include the commission that they need to pay to the distributors. These commissions could range between 0.8% to 1.5% every year. These are passed on to the investors by reducing their mutual fund NAV. With direct plans, you are investing directly with the fund house. So, you can invest without paying hefty commissions to the distributors. You enjoy 100% of the benefits of your investments. This could lead to a massive difference in returns over the long run. For instance, the regular plan of Axis Long-Term equity has an annual return of 14.17% whereas the direct plan for the same fund has delivered a 15.3% yearly return for the last three years. You must not underestimate the impact of this difference. Even a difference of 1% with the compounding effect in the long-term can mean lesser money for you.

Net Asset Value (NAV)– As direct plans have a lower expense ratio, they tend to have a higher NAV each day when compared to direct plans. Don’t let this deter you from investing in direct plans as direct plans provide higher returns.

Also read: Can I switch regular plan of an ELSS fund to direct plan?

Who should go for direct plans?

Everyone should opt for direct plans as they help save a substantial amount of money. It is also good for those who want to invest in mutual funds without any intermediary. Fund managers can generate better returns, thanks to the reduced expense ratio. People say that the disadvantage of direct plans is that investors are advised to do their market research to select performing mutual fund schemes. You will need to do all the paperwork on your own. You can analyze by reaching out to mutual fund websites and blogs to know more about the top mutual fund schemes. If you think this is hard work, choose RIAs such as Moneysage. They can help you invest in direct plans that suit your profile.

Should you choose regular plans at all?

While direct plans are cheaper, you may not get investment advice if you don’t go to an RIA. An advisor can help you analyze the track record of the funds, match your risk profile to different funds and will invest your money in a fund that is suitable for you’re the financial goal that you are investing for. This research need is met by the distributors and advisors. Only if you can’t find a good RIA and don’t find the time to research on mutual funds, you should go for regular plans.

Also read: Mutual Funds: Direct Plans vs. Regular Plans

What should you do?

The first lesson you need to learn is that ratings of mutual funds are not the be-all and end-all of mutual fund investing. They should be only one of the measures you use to shortlist funds and to eliminate the bad funds from your list rather than using them to invest in funds. Also, when everyone starts investing in 5-star rated funds, the fund’s Assets Under Management (AUM) becomes more and the returns might turn into average as the fund may not be able to trade quickly in the market. Another important point is that most rating systems create categories based on asset classes and then classify mutual funds into the categories. The mutual fund ratings show only the relative rating of funds in that category. The mutual fund ratings do not reflect the credit rating/investment agency’s view on the asset class. For instance, a five-star rated banking fund is not a recommendation to buy banking funds. It just means that if you have decided to buy banking funds, this is a good one. However, most investors do not understand this.

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So, don’t rely on only the star ratings of funds. 

Understand that direct plans are meant for all investors.  You don’t need to be an investor who has the time and skill to research, select and review mutual funds on your own. You can take the help of an RIA to invest in direct plans. If you are a savvy investor, then it is a waste to invest in regular plans. So, if you are investing using websites such as ICICI Direct, it is time you move on to Moneysage for direct plans.

Remember that you can always seek professional advice from a SEBI registered RIA like Moneysage. These advisors can help you select the right funds, invest in direct plans and inculcate investment discipline.A SEBI RIA will usually charge a fee for the service. The fee can be a flat charge or a percentage of your mutual fund portfolio. You will pay much less over the long term if you opt for a good fee structure,

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