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Due to the absence of a third-party intermediary between investors and fund companies, direct funds have a lower fee ratio than regular funds.

It was in January 2013, that the market watchdog Sebi mandated the fund houses and asset management firms (AMCs) to categorised mutual funds into two categories, namely regular funds and direct funds. A direct mutual fund is purchased directly from the fund house or AMCs by investors. In this case, between investors and fund houses, there is no intermediary, agent, or distributor.

That said, a regular mutual fund is distributed by a third party, agent, or distributor. When the agent successfully finds the investors, the AMC pays the agent a commission or brokerage fee. As a result, the expense ratio of regular funds would be greater than the expense ratio of direct funds. However, the regular and direct funds would have the same asset allocation, investment objective, and fund manager(s).

Direct plans benefits

Reduced expense ratio

Due to the absence of a third-party intermediary between investors and fund companies, direct funds have a lower fee ratio than regular funds. In regular funds, AMCs compensate agents for their services and recoup their costs through an expense ratio. Direct funds generally have 1% lower fees than the regular plans. While the expenditure ratio difference between regular and direct funds may appear insignificant at first, it quickly grows significantly.

Increased net asset value

A mutual fund’s net asset value (NAV) is the ratio of the value of the fund’s total assets to the number of outstanding units. NAV = (value of owned assets) / (outstanding units). A mutual fund’s assets can include stock in numerous firms, debt instruments such as bonds, treasury bills, and cash. Because direct funds do not charge trading fees to investors, their net asset value (NAV) will be higher than ordinary funds.

High profitability

Direct funds have a lower expense ratio than ordinary funds because there is no brokerage or commission required. Although the difference in returns between regular and direct funds may not appear significant, it is when investing for the long run.

As per the data by the Association of Mutual Funds in India (AMFI) for July 2021, individual assets are primarily distributor-driven as 58% of the assets of individual investors came from T30 cities and were brought in by distributors.

Whereas direct investments accounted 20% of individual assets, divided as 4% from B30 and 16% from T30. Reduced transaction costs and simplicity of doing business are just a few reasons investors are shifting to direct plans.

Additionally, there is a dearth of high-quality distributor services, which has resulted in investors shifting to direct mutual fund plans. If this trend continues, direct plans for T-30 cities’ AUM could surpass that of regular plans.

That said, most fintech mutual fund distribution platforms also do not charge commissions and focus on direct plans with lower total expense ratios than regular plans.