The Dangers Of Direct

“Direct Plans” seem to be quite the buzzword on the block when it comes to Mutual Fund investing. And why not? We’ve even got AMFI, the apex body, promoting them in good measure in between overs during the World Cup telecast. And of course, the internet is inundated with calculations of how direct plans are better than regular plans, because imaginary future commission savings add up to such large a quantum of money saving over the years!

But there’s another peculiar phenomenon taking root. Over the past few months, we’re witnessing a steady trickle of direct plan investors returning to “advised” regular plans; and most of their portfolios appear to have similar constructs. Here are some frequently observed commonalities. 

First, it seems that direct plan investors are prone to “portfolio clutter”, wherein small and often inconsequential amounts of money are parked across tens of different Mutual Funds. This isn’t surprising, because direct plans tend to commoditise Mutual Funds and investors in these plans tend to “buy” rather than “invest” as part of a well-planned strategy that’s in sync with their goals and risk profiles. A little bite here, a little there… a small chunk of an NFO here and a little money put away in a fund that earned good returns for their friend… and a little more in “that low expense ratio fund” … this is generally how direct plan portfolios are built over time. The result, naturally, is a highly inefficient portfolio with a slender chance of beating benchmarks – after so much hard work put in!

Second, very few direct plan investors seem to have a solid asset allocation strategy in place. Money flows in and out of their portfolios in an ad hoc manner, without proper regard to which asset class deserves more weightage with respect to their investment objectives. We see near retired individuals holding 100% equity portfolios, and youngsters no more than thirty running their long-term SIP’s into debt funds. It would seem that designing – and more importantly, enforcing – a top down asset allocation strategy, is more difficult than it comes across, prima facie!

Third, we typically don’t see any strong logic with respect to the core fund selection methodology itself. We see high risk taking, Alpha seekers investing into index funds simply because they are cheaper. Or for that matter, debt fund investors shovelling money into “high YTM” funds without due consideration of the fund’s lack of diversification or potentially catastrophic default risk. And the worst of them all – investing into a fund purely based on its trailing 12 month returns, as was the case with so many small cap fund direct folios at the end of 2017! Many more such faulty fund selection methodologies abound within the said community.

Fourth, we see a lot of behavioural factors in play. For instance, a large dollop of money allocated to an equity fund right after the election verdict was announced, or complete exits from credit risk funds after their top holding defaulted and left a gaping hole in its NAV (talk about bolting the door after the horse has fled!) Frequent churn, based on the noise emanating from the “Bubble-vision” isn’t uncommon, either.

Needless to say, all these factors contribute to a very poor investment experience for a lot of direct plan clients, especially for those not to adept at investing. And to be fair, the problem isn’t with direct plans per se, but with investing “unadvised”; after all, the RIA model in which the client pays a fee to the advisor in exchange of fiduciary advice is still a few years away from take-off (optimistically speaking). With vast swathes of the investing community migrating away from the haven of traditional instruments into Mutual Funds, one has to wonder whether the impact of direct plans on the industry will be net-positive in the long run.

If you’re contemplating going direct & unadvised, pause for a moment and consider whether the cost saving is worth what you’ll be giving up in the bargain. More often than not, the support of a well-meaning and competent Financial Advisor can make a world of difference to your investing outcome.