Why do regular plans dominate some types of mutual funds and not others?

Mint analysed India’s top 15 fund houses in terms of assets under management (AUM) to see which of their equity funds had higher share of regular plans and which had higher share of direct plans.

Data revealed that many funds launched in the past four to five years lean heavily on regular plans for their AUM, especially thematic and sectoral funds, as these account for most of the new launches in recent years. On the other hand, direct-plan investors have a preference for passive funds.

Regular plans

“India’s mutual fund industry is still at the stage where it is in B2B (business-to-business) mode. Hence, new fund launches go through the distribution mode. Often, these are distributed through the associate platforms of the fund house,” said a senior executive at a fund house, who did not wish to be named.

Data shows that it is not just thematic and sector funds where the share of regular funds is on the higher side, but also broad-based fund categories such as multicap funds and multi-asset allocation funds, as these categories have also seen some new launches in recent years.

According to data from the Association of Mutual Funds in India, six of the top ten mutual fund distributors in AUM terms are banks and their subsidiaries. This is according to data as of 31 March 2024. The latest figures are yet to be released.

Various analyses have also shown that certain banking channels favour their own fund house’s schemes. This is also true of new fund launches. Mutual funds sold through banking channels also fall under regular plans.

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“Most of the large fund houses have their captive banking distribution channel,” said Amol Joshi, founder of Plan Rupee Investment Services.

According to Chennai-based mutual fund distributor D Muthukrishnan, it is not just new funds but also those with a smaller scheme size that have a higher share of regular funds. In India, mutual funds are still a push product and new schemes or smaller schemes (which may also be fairly new) need to have their merits and demerits explained to investors.

“Having said that, unlike developed markets, alpha can still be generated in actively managed funds in India. Over the long-term, actively-managed funds have shown alpha post-expenses,” Muthukrishnan added.

Alpha is the outperformance a fund generates against its benchmark index. For example, a flexicap fund’s performance is measured against the Nifty 500 Total Return Index (TRI), which accounts for both the dividends and capital gains from stock price movements. 

‘I don’t pick thematic, sectoral funds’

Muthukrishnan added that he doesn’t pick thematic or sectoral funds for his investors as these require timing the entry and exit to perfection. “Predicting the perfect time to enter and exit a theme or a sector’s business cycle is not possible on a sustainable basis. Diversified fund categories such as flexicaps can do this better as they allow the fund manager the freedom to take those calls. In a sector or a thematic fund, the fund manager is actually forced to stick to the theme or sector, as that’s the scheme’s mandate,” he explained.

The Securities and Exchange Board of India has put in place total expense ratios (TER) on the basis of slabs of scheme sizes. This slab-based TER structure is to allow newer fund houses to incentivise distributors to increase their size and compete with larger fund houses. Schemes with a lower scheme size – up to ₹500 crore – can charge the maximum TER of 2.25%, which is reduced as the scheme size progresses across different slabs.

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“It is a well-intentioned slab structure, but it should not be misused. Investors’ interest should be prioritised,” Muthukrishnan said.

The TER varies between regular plans and direct plans as distributor commissions are embedded in regular plans, while no commissions are added in direct plans. An advisory fee may be charged separately in the case of direct plans, if the investment is made through the advisory route. For do-it-yourself investors, there is no advisory fee either.

Direct plans

Direct-plan investors fall under two categories – DIY investors and those who are advised by registered investment advisors (RIAs).

According to Vishal Dhawan, founder of Plan Ahead Wealth Advisors, the higher share of direct plans in passive funds may also be due to the preference of fund houses. “Fund houses may prefer certain schemes to be distributed and some to go the RIA route. So that also influences these shares,” Dhawan said.

“Certain private banking channels and wealth platforms offer advisory services under the RIA code and only offer direct plans as advisory fees are charged separately,” said another senior executive of a fund house. 

Dhawan added that there are also many institutional and corporate investors on the passive side. “On the passive side, the only significant differential may be the expense ratios, as passively managed funds within the same category seek to replicate index returns,” he said. 

“For a new fund launching a passive fund, the focus at times is on becoming the cheapest index fund in that category in terms of TER, to gain traction,” he added.

“Investment advisors prefer a combination of actively-managed funds, passives and smart-beta funds for their clients, depending on their goals, apart from other relevant categories on the debt and hybrid side,” Dhawan said.

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Kavitha Menon, founder of Probitus Wealth, said, “We prefer passives and index funds for clients to give them low-cost options, but not necessarily plain-vanilla index funds. These could be smart-beta options that offer a rule-based strategy with an existing index – what are also known as factor funds.”

According to Joshi and Muthukrishnan, some DIY investors believe actively managed funds can’t beat benchmark returns and that they are better off with passively managed funds.