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Distributors Right to be Wary of Direct Plans

SEBI’s move to mandate direct plans will enhance investor returns, but distributors are wary of lost business

From January 1, 2013, all mutual funds sold in India will be required to have something called a direct plan. This direct plan is intended for investors who deal with a mutual fund directly, without going through an intermediary distributor. Investors can still do that, but they don’t get any advantage for doing so. When an investor goes to a fund’s own office and invests (or does so online) then the fund company’s expenses are presumably lower. Brokerage and commissions paid to the distributors, which are a major part of fund companies’ expenses, don’t have to be spent for such customers.

Up till now, when a customer dealt with a fund company without going through a distributor, the money that didn’t have to be paid to a distributor went to the fund company, adding to its margin of doing business. There was no particular advantage that the investor derived by doing things directly.

This will change now. From next year onwards, the savings that a fund company derives from spending less on direct investors must be passed on to the investors by not deducting it from their NAV. This will mean that direct investors will now get a different, higher NAV and will thus have to be placed in a separate plan of the fund.
The interesting thing is that this is not the first time that direct investors have an advantage over others. Back in 2007, SEBI had decreed that funds should not charge any load from direct investors. This meant that the same amount of money got direct investors more units, even though the subsequent NAV was the same. This advantage disappeared in July 2009, when SEBI abolished load for all investors.

It remains to be seen how much lower the expenses (and thus, how much higher the returns) of the direct plans are. Although funds will not have to pay distributors for the direct investors, they’ll still have to incur some expenses in processing the investments. Nevertheless, industry insiders estimate that direct investors could have an advantage of about 0.5 to 1 per cent per year for equity funds. Over five years, this would accumulate to an impact of about 5.2 per cent.

This is not a small differential but it does have to be seen in the context of equity funds’ returns, where the impact is nowhere near that of other factors, like the choice of the fund itself. For example, over the last five years, Rs 1 lakh invested into the best large cap equity fund would have become Rs 1.5 lakh. In an average fund, it would have become Rs 1.21 lakh while in the worst fund it would have become Rs 91,000.

Still, higher returns are higher returns and the distributor community fears that over time, larger and more knowledgeable customers will gravitate towards direct plans. They fear that they’ll do the initial hard work but once investors learn the ropes, the cream of the customer base will go over to direct. This fear is not unfounded. Like physical businesses in on online world, such disintermediation is bound to happen. However, there’s no real solution except to be work towards being of additional value to customers.

There could also be new business models possible. One medium-sized distributor told me that he was hoping to charge for advice and service and ask investors to go the direct route, thereby clearly showing his hands as being the investor’s man, and not the fund companies’. Investors too should clearly evaluate the distributor’s services and be willing to pay for the value delivered.

Still, the direct route is bound to cause trouble for many distributors. Many will adjust to it but some may see a severe business impact. SEBI’s concern for investors’ interest is laudable but the real issue for many is that it’s hard to change one’s business dynamics frequently.