According to the Securities and Exchange Board of India (SEBI), there are two types of mutual funds issued by asset management companies (AMCs): regular funds and direct funds.

Let’s take a closer look at direct funds – What are direct funds and what are their advantages over ordinary funds?

What are direct funds?

Direct funds are mutual fund schemes that are sold directly by the fund house or asset management company. The word ‘direct’ is affixed to the names of these funds. There is no third party, distributor, or agent involved. Investors engage directly with the asset management company (AMC) that is offering the product. There are no commissions or brokerage fees in these transactions because there is no involvement of a third party. As a result, the expense ratio of direct plans is lower than that of traditional funds.

Features of direct funds

The following are the key features of direct funds:

  • Investing does not require the involvement of a third party.
  • Direct funds can be purchased both online and offline.
  • Because there will be no commission to pay, the fund house will not charge a distribution fee, keeping the expense ratio low.
  • There are no transaction fees.
  • The term ‘direct’ refers to monies that are invested directly.

Best direct fund

The best direct mutual fund would have the attributes listed below:

  • Has provided good returns over a long period of time and is frequently unaffected by market changes.
  • When compared to peer funds, the expense ratio is lower.
  • Provides portfolio diversity.
  • The fund manager has a proven track record of success.

What are regular funds?

The mutual fund schemes that are distributed through agents and distributors are known as regular funds. Regular funds have commissions or brokerage fees because investors do not deal directly with the fund house. The commission is not paid directly to the agent by the investor. Instead, the fund company collects it and pays the agent or distributor through the expense ratio. As a result, regular funds have a little higher expense ratio than direct funds.

Differences between a regular plan and a direct plan in mutual funds

Regular and direct mutual funds offered by a fund house would have the same asset allocation and fund manager(s). The only difference between these funds is the commissions or brokerages. The key distinctions between regular and direct funding are shown in the table below:  

ParameterDirect FundsRegular Funds
Third-PartyNot presentPresent
Expense ratioLowerHigher

Advantages of investing in direct funds

The following are some of the major advantages of investing in direct funds:

  1. Low Expense Ratio: The expense ratio of these funds would be lower than that of ordinary funds because there is no third party between you and the AMC. In traditional mutual funds, the AMCs pay the agents a commission, which they recoup through the expense ratio.
  2. Higher NAV: A mutual fund’s Net Asset Value (NAV) is determined by dividing the entire value of the assets in the portfolio by the number of outstanding units. Because no brokerage fees are charged, the NAV of these funds will be higher than that of normal funds.
  3. High Returns: Because direct funds do not require brokerage, their expense ratio will be lower than that of ordinary funds. The difference in returns between regular and direct funds may appear insignificant, but it can add up quickly if you stay invested for a long time.

Here’s an illustration: Assume you invest Rs 12,000 per month in a SIP for the next eight years, in both regular and direct AMC plans. Consider the 11 percent and 10% returns generated by direct and conventional funds, respectively. The AMC pays a 1% brokerage fee to the third party in the case of standard funds. The corpus accumulated at the moment you redeem your units is shown in the table below:  

ParameterDirect FundRegular FundDifference
Monthly SIP amountRs 12,000Rs 12,0000
Investment Tenure8 years8 years0
Returns 12%11%1%
Amount accumulated at the time of redemptionRs 19.19 lakhRs 18.34 lakhRs 0.85 lakh
  • No Conflict of Interest: You eliminate the possibility of being mislead by a third party because you interact directly with the fund house. For their own benefit, an agent or distributor may persuade you to invest in specific mutual fund schemes. As a result, investing in direct funds avoids the potential for a conflict of interest.

FAQs (Frequently Asked Questions)

As a tax-paying citizen, you can take advantage of Section-80c of the Indian Tax Act, which allows you to deduct up to 150,000 from your total yearly income.

Which are the best mutual funds to invest in in India?

Depending on your investment objectives and risk tolerance, you may want to consider selecting the finest mutual fund. Before investing in a mutual fund, you should look into the track record of the mutual fund house and the fund manager. However, you should only invest in a mutual fund if you are happy with the fund manager’s investment style.

Before investing in a mutual fund, make sure to verify the fee ratio. The best mutual funds might have a lower expense ratio. However, before investing in a mutual fund, you need to look at a few other key factors. You’ll notice that the best mutual funds have a lower portfolio turnover ratio. You should avoid mutual funds whose portfolios are churned frequently by the fund manager.

Depending on your investing horizon, you can choose the best mutual funds. You can only invest in equity funds if you have a three-year or longer investment horizon. You can invest in debt funds for a period of fewer than three years. Only invest in balanced or hybrid funds if you have a three- to five-year investing horizon.

You can compare mutual fund performance to a benchmark index to find the best mutual funds. You can compare the performance of a large-cap fund to the Nifty 50 index, for example. Compare the mutual fund’s performance to that of its peers, as well as the consistency of its performance. Over a period of five years or more, the best mutual funds have consistently outperformed peers and the benchmark index.

You must select the greatest mutual fund house with a significant amount of assets under management (AUM). If the fund company manages a big amount of assets, it may be able to withstand sudden redemption demand.

How to find the best performing mutual funds in India?

Best performing equity fund:
If an equity mutual fund consistently outperforms its benchmark index over time, it may be the greatest performer in its category. When compared to peers, the best-performing equity fund has a lower expense ratio. The best-performing mutual funds may outperform during all market cycles.

To find the top-performing mutual fund, look at the alpha of the equities fund. The excess return earned by the equity fund over the benchmark index is shown. You can choose an equity fund with a higher alpha than its peers.

The equities fund’s beta is something you should look into. It tells you how volatile the fund is in comparison to the benchmark index. When compared to a fund with a beta greater than one, an equity fund with a beta less than one is less volatile.

Look at the standard deviation to get an understanding of how volatile the equity fund is. When compared to a fund with a smaller standard deviation, you may find an equity fund with a larger standard deviation to be riskier. Based on risk-adjusted returns, you can choose the best performing equities fund. Examine the equity fund’s Sharpe’s ratio and choose an equity mutual fund scheme with a higher Sharpe’s ratio, which indicates a higher risk-adjusted return.

Best performing debt fund:
You could want to choose the best debt funds based on the credit quality of the bonds in your portfolio. Bond issuers would be assigned a credit rating based on their capacity to repay the principal and interest payments. You must put your money into debt funds that have AAA-rated bonds in their portfolio.

It is a more secure investment than lower-rated bonds, which may pay a greater interest rate. They may, however, fall behind on both principal and interest payments.

Based on the expense ratio, you can choose the best-performing debt fund. A debt fund with a high expense ratio should be avoided. The best debt funds have a three- to five-year track record of performance. You can choose the finest debt fund if the average maturity term corresponds to your investing time frame.

Best performing hybrid fund:
You might choose the best-performing hybrid fund with a three- to five-year track record of performance. Choose a hybrid fund that has outperformed its benchmark index and rivals over time.

Before choosing the top-performing hybrid fund, look at the fund house’s track record and the fund manager’s investment style. Choose a fund house with a large number of assets under management that can withstand large-scale redemption pressure.

Choose the most profitable hybrid fund with the lowest expense ratio. A high expense ratio could eat into the fund’s return. Your investing objectives and risk tolerance must be met by the best hybrid funds. Take a peek at the cautious hybrid fund portfolio. It offers you an understanding of the bond portfolio’s credit quality.

Read, also: How Do Mutual Funds Work And How To Invest Them Online?