On Direct MF Plans, Ethics, Conflict of Interest and All That Sort of Thing

Scenario 1: A certified (certifiable?) financial planner tells his client: “do you want to invest in direct mutual funds? They may give better returns but did you know that this is only suitable for those who can choose and manage their funds on their own? You don’t need to take this burden on yourself, let me (continue to) do this for you”. (I can of course get a fee from you for investment advice alone but I want trail commissions from your investments too. Besides, if you go ‘direct’ I have to get the MF fund portfolio history from you and not from the AMC. This is too much of a pain for me analyze and advice). Bracketed sentence thought but not spoken.

Scenario 2: A certifi… financial planner discusses in length in his blog tax efficiency of certain debt instruments and how even small post-tax return differences can matter.  In his next post he covers direct vs. regular plans of MFs. He mentions in passing how direct plans can result in a return difference of about 0.4-0.7% each year and then goes on to discuss para after para about the disadvantages of investing directly.  Through his blog, needless to say, he is on a mission to promote financial awareness and literacy.

Source: Casey Wheeler Consulting

Let us look at them again:

Scenario 1: The certifi… financial planner A. True story? True enough story? Exaggeration? I will be happy to think so but scenario 2 worries me.

Scenario 2: The certifi… financial planner B. True enough story based on composite planner behaviour and quite disturbing, to say the very least. Here are few such articles (more can easily be found):

Lengthy process, but higher returns in direct MFs

Direct Plans are not a threat to genuine Financial Planners/Advisors

(registration required)

MF direct plan investment to have tax implications

Why is scenario 2 disturbing?

A certified financial planner has a very specific code of conduct and set of ethics to follow. These include:

  •  “….not place personal gain or advantage before the client’s interests.”
  • “not solicit clients through false or misleading communications..”
  • “…honesty and disclosure of material conflicts of interest.”
  • “Professionalism requires the Financial Planning professional, individually and in cooperation with peers, to …serve the public interest.”

I strongly believe one-sided articles by CFPs in which the disadvantages (to the investor) of going ‘direct’ are overtly emphasized, giving the impression that they are insurmountable are violations of the CFP code of conduct/ethics. None, repeat none of the issues mentioned in these articles are insurmountable.

A fee-based planner (one who gets a fee for planning and commissions from AMCs for MF investments) advising against direct plans is a blatant instance of conflict of interest.

Not trying to say everyone is doing it, but that enough people are. Few planners to their credit do encourage their clients to go 'direct'. Incidentally Value Research Online has also joined in the tamasha. One day they advice: (Direct plans are the) Best mode of investing in mutual funds. The very next day their CEO (under pressure?) writes, Direct, Indirect or Nothing?, nearly reversing the stand.

What are the issues?  If investors go direct,

  1. fee-based financial planners will lose out on trail-commissions.
  2. fee-based financial planners cannot retrieve investor data feeds (transactions, redemptions etc.) from the AMC. They will have to get the information from the investor and work on it. This may take longer. Here is an extreme statement: “advisor will no longer have access to investor’s information and therefore portfolio reviews and rebalancing, shifting from equity to debt funds depending on goals, strategic asset allocation may not be possible.”
  3. intermediaries/distributors will lose business

What can/should planners do?

  1. The first issue is financial. More than 90% of planners are fee-based. So I would think there is a strong enough dependence on commissions for survival. Fee-based planners will have to charge a higher fee to the direct investor. Many have started doing this. A separate service for ‘direct investors can also be provided. Sadly no one wants to consider this possibility.
  2. The second issue is a non-issue. To say rebalancing may not be possible with a direct investor client is nonsense. To say this will cause errors borders on incompetence. Clearly mention to the client that it his/her responsibility to provide portfolio information. A fee can be charged for extra work put in by the planner to analyze the information from the client.
  3. I don’t have a business bone in my body but I would guess that sheer investor laziness (to learn), if not prudence to use (the distributors) value-added services will keep intermediaries/distributors afloat.

Of course a planner can increase the fee and inflate it each year to exactly offset his loss (clients gain) in trail commissions! On the other hand the client may not pay and the planner may lose him/her. Either way tough luck!

Of course many investors do not know how to choose a MF. Of course picking the right MF is more important than lower expense ratio. I always tell my students: Ignorance is not a crime. Staying ignorant is. In this case, I would think, encouraging someone to bask in their ignorance by lob-sided representation also is.

To say, ‘a new investor should go the ‘direct’ way’ is utter nonsense. Selecting mutual funds is neither rocket science nor brain surgery. Anyone with a little inclination can do it.  (Here is a step-by-step guide to choose an equity mutual fund). Direct MF plans offer a wonderful opportunity for any investor to learn.

 The REAL issue: Unfortunately very few people want to learn. Most want free advice, free service and great tax-free returns. Want to adopt a ‘fill it, shut it forget it’ approach to investing and at every opportunity want to hide behind their ignorance.

 What should investors do?

It is your life, your investments, your goals. If you don’t make the effort, read and understand investment options, who else will? Please remember MF investment is not a laundry service. Whether we do it ourselves, through a planner or an intermediary, we have no choice, repeat no choice but to learn and understand the nature of the investment. Using a planner or an intermediary like FundsIndia for convenience and their value-added services is fine, provided we don’t compare returns with a ‘direct’ investor down the line. The point is we must make an informed choice depending on our personal situation and not waver. Whichever way, lets make an effort to learn before life chooses to teach us a thing or two. Let us remember that she does not suffer fools gladly.

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20 thoughts on “On Direct MF Plans, Ethics, Conflict of Interest and All That Sort of Thing

  1. Ramesh

    A very decent meta-analysis article.
    I would just like to add one thing. Too many people think that 0.5% is just 0.5%, what difference can that make (mostly because of ignorance). But if a long term return of 12% is considered, a 0.5-0.6% of net corpus will actually translate into 4-5% of total return (for debt funds, the net effect is even larger). And in the retirement phase, when the withdrawal is needed at the rate of 4-5%, the same 0.5% will mean that one will need a 10% larger corpus if you use an intermediary as compared to not using one. In short, it is a huge difference.
    And yes, there is a huge conflict of interest when the advisors act as distributors. Previously, this option was not there, so the business could work like that. But now with the advent of Direct Plans, ethically it is not sustainable.
    Within 3 years (since that is what most online star rating agencies use as a cutoff mark for rating), there will not be a single fund which will NOT have - Direct in the top charts!!
    Also, the investors themselves are mostly to be blamed if they want to remain lazy or do not want to pay those few advisors who would work in an ethical manner.

    Ultimately, it is the investor's job and responsibility to best manage his/her money, and not the distributors.

    Reply
    1. pattu

      Awesome points as usual. I think the difference is deliberately being downplayed and VRonline is contributing to it in its own way. Thanks your views offer great perspective.

      Reply
    2. Rajesh Sharma

      Every year market finds its bottom for that FY once or twice, one timely switch for the client, will save 5-8 % for the client. Which would be as good as 5 -8 years of differential return. The biggest problem with AMCs is that they can not withdraw all the funds, despite knowing that the market is about to fall. I use it with my clients, they are happy with it.

      Think & promote accordingly

      Reply
  2. prakash

    Very good analysis indeed!
    Promoting direct plans and online term insurance is the need of the hour if we want financial literacy to go to the next level.

    Reply
    1. pattu

      Dear Mr. Praharaj, delighted to hear a CFP like you say this. I think if the planning community shed their insecurity and promote direct plans, in the long run it will only do them good in all ways.

      Reply
      1. prakash

        Dear Mr Pattu,
        There are CFPs who are client focussed in true sense of the term although they are in a minority.Their number is not growing because very few clients are willing to pay for advice.Hopefully things will improve in the coming days.

        Reply
        1. pattu

          Undoubtedly. Fully agree about investor behaviour. Most of them cannot spend the time to do it themselves. They must then understand the consequences of not seeking professional advice in time.

          Reply
  3. Syamantak

    A recent trend of debating articles on Direct or Indirect method of investment into MFs, has been noticed. Its just like the way many novice bloggers come up with a 'review' (read as replica of scheme brocheure with some excel calculation) of some LIC Jeevan 'xxx', immediately after they are launched 🙂
    I was not very happy to see my RSS feed showing up a similar article on your blog, since I always admired you to be a very good critic/analyzer on this field. But boy, I must say, you always exceed expectation! This one is the most unbiased article, I have seen on this topic. Liked the way you tried to explain it to the ignorant investors 🙂
    Please keep up the good work!!

    Reply
  4. vignesh

    Awesome !! Actually Your previous four or five articles was very good!!. (I started reading your blog from their only, I came to know from subramoney). i follow many blogs for the past 1.5 yrs. But your blog is totally different to all that i have encountered.

    You are an excel specialist I will say!!!

    I was thinking on creatiing one for the retirment corpus calcualter with yearly withdrawl for my mom and dad. You totally helped me in doing that.

    thanks. Slowly I am also moving my investment to direct plans.

    Regards
    Vignesh

    Reply
    1. pattu

      Hi Vignesh, Thanks for your kind words. Excel has awesome capabilities. I know only a fraction of that. codes can be written more efficiently with other packages like Mathematica but not many people use it.

      Reply
  5. Mohit

    Pattu
    Its too much getting into your own thoughts and presenting the things, what if i give fee based advice and do not ask for trail commission.
    Why you guys do not come out of your rigid thoughts and think like a layman...
    I do not know what is mutual fund and you are asking me to go for direct plan.
    .5% may be big in very long term, how many investors are investing for that long term.
    How many financial planners you know who actually do not ask for trail commission?
    Ok, the fact is, we are not smart investors. Please help us to take a smart and informative decision...not by your more than smart comments but by giving us the information....as no banks..no insurance companies..no mutual fund companies are giving it... only a few bloggers who are trying it..

    Reply
    1. pattu

      Dear Mohit,

      Thank you for comment.
      " what if i give fee based advice and do not ask for trail commission." I have mentioned this in the article. I think it is a good thing to do. I am hardly ever rigid in my thought process. I think have done a reasonable job of covering the perspective on both sides.

      "I do not know what is mutual fund and you are asking me to go for direct plan." I have often said that investors have only two choices: either read and do it yourself OR get help from a planner. Same reasons for
      "how many investors are investing for that long term."

      "How many financial planners you know who actually do not ask for trail commission?" Yes agreed only a few. They cannot survive otherwise. My point is before direct plans came it didn't matter what planners did. Now that they are here they are obliged to offer clients a choice. My point is they should ask for a higher fee from direct clients instead of saying vague reasons like "I cannot advice your properly if you go direct" This is plain unethical.
      Yes asking for higher fee means chance of losing clients. This is where planner competence and trust he/she has gained from clients matter.

      What information on investing are you referring to? If can provide it, I will be happy to help.
      Thanks again for your time.

      Reply
  6. ddshah

    Pattu,Nice one..pl guide me in caculating LTCG & STCG in various transection made during year..i mean to say presently my agent gives me tools to calculate backdate various analysis of my investment including Cagr,profit loss,amc vise distribution,schemwise holdings in all AMC,...likewise.i am afraid how can i get such analytical tools without such help...pl guide me...i m really confused...regards

    Reply
  7. Sebastian

    My advisor tell me that direct plans have a service tax component of 14.5% which is borne by the investor and thats not the case in regular plans. Is this true ?

    Reply

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