Lengthy process, but higher returns in direct MFs

For those investing in big chunks, like HNIs and corporates, the direct mode is useful, as they have resources to invest directly and handle issues along the way

SEBI has been a great votary of investor protection. There are many laws it has brought in specifically to help investors. Not all have been helpful for investors. In fact some of them have had unintended consequences for investors.

The latest from SEBI is the direct option in Mutual Fund schemes. Let us first understand what this is. Here, the expense ratio will be pegged at a lower level, as compared to the schemes distributed by intermediaries, as their commission can be saved. This is akin to asking Godrej to sell a soap at their factory outlets at a lower price, though their retailers will be selling the same soap in their shops at a higher price. This would create a curious situation where the same product is available at two different prices and Godrej is in competition with it’s retailers. That would now happen with Mutual Fund houses and their distributors.

Will MFs benefit
If investors are motivated to invest in the direct mode, Asset Management Companies (AMC) will have to augment their team for handling the volume. The real retail crowd requires a lot of hand holding and these people will take up quite a bit of time and band-width, if they land up in the AMC’s points of presence. So truly, there may not really be any savings for the AMC. In fact, their costs may go up as their staffing is costlier, as compared to the staffing of distributors.

NAV IN DIRECT PLAN IS HIGHER:
If the expense ratio is lower, like in the case of direct plan, the expense deducted per unit is lower. In the regular plan, the expenses charges will be higher. Hence, the NAV in the direct plan is higher due to the lower expenses and the NAV is lower in the regular plan due to the higher expenses charged in this plan. The expense ratio is the total annual expenses charged to the scheme, which include the Asset Management fee, Marketing expenses, audit fee, custodian fee and so on. These expenses are divided by the number of units to get the expense to be deducted per unit. Let us take a simplistic example to illustrate this point.:
	Direct	Regular
Number of units	10,00,000	10,00,000
Current NAV	20	20
Value of assets	2,00,00,000	2,00,00,000
Expenses per annum	2.00%	2.50%
Total Expenses charged	4,00,000	5,00,000
Expenses per unit	0.4	0.5
NAV after expenses	19.6	19.5
Note - NAV is calculated daily after deducting the expenses applicable on a pro-rata basis not as shown above.  The above is just to illustrate the principle as to why NAV in direct plan is higher than Regular plan.

So, even though SEBI is perhaps hoping that the direct option would entail lower costs for AMCs, it may happen that the regulator may have to lean on the AMCs to artificially lower the expense ratios for the direct option. AMCs have to have another scheme called Direct apart from the regular one, for which they have to maintain a different Net Asset Value (NAV). All these increase their costing. This will affect the profitability of AMCs, that too, at a time when many AMCs are making losses.

Will clients benefit
You may argue that shopping at factory outlets is cheaper than shopping at a retail store. All you have to do is locate a factory outlet of your favourite brand of apparel or footwear. But in case of financial products it is not so easy.

If clients want to bypass distributors and do things directly, they will have to fill out the forms and submit it at a Point of Sales (POS). Now, that seems easy. But, today, that is easier said than done. For instance, if a couple is investing in a MF scheme and the wife is the second applicant and she issues the cheque, the application will be rejected if the cheque does not bear her husband’s name.

As a supporting document, a copy of the passbook will also have to be given, which shows both of them as account holders. So, that will entail a second visit.

Let us take another example. Suppose the wife invests in a scheme and the husband issues the cheque from his salary account, there is a third party declaration to be given. If his wife genuinely does not have a bank account or any other address proof, then the husband’s address proof and their marriage certificate would be required.

Assuming the wife has some address proof, but does not have a bank account and gives her husband’s account number, at the time of redeeming the MF, she will face a problem as the cheque will be issued in her name though the account does not have her name. To take care of that, at the time of cashing out, she will have to give her old account details, including cheque and passbook and the new account details including cheque and passbook. Since the old account is in the name of the husband, she will have to go to the branch and prove the relationship. If the old account was closed longback and one does not have any proof that they had that account, then it will be a herculean task to get the money.

So, it is not a painless process for the clients. In fact, MF investments, today, have become quite cumbersome. They will have to go through the motions, bite their lip and keep reprocessing. In the process, lots of investors may give up, in between. In a lot of cases, the statements have errors, which need to be rectified. This will become a full-time job rather than a diversion.

Investors would end up spending more time, effort and money in doing things themselves than they would save from the Direct mode, in terms of lower expenses. Only in case of those who invest in big chunks, like HNIs and corporates, the Direct mode will be useful as they have the resources to invest directly, and handle any issues along the way. There is lots of work to be done while doing MF investments today.

As an investor, you need to decide if you want to do it or you want to get it done. While it may earn you higher NAVs, you will have to do the process on your own.

The author is the Founder of ‘Ladder7 Financial Advisories’