/Why is your direct plan rated lower than the regular plan of same mutual fund scheme?

Why is your direct plan rated lower than the regular plan of same mutual fund scheme?

A Do-It-Yourself (DIY) investor recently stumbled on this puzzling data while researching short duration debt mutual fund schemes in an online website. She was surprised to note that the website has rated the regular plan of HDFC Short Term Debt Fund five-star, while the direct plan of the same scheme was rated a notch below at four-star.

She just couldn’t figure out how such a difference in the ranking is possible. Her reasoning was if the direct plans are supposed to give better returns than the regular plans, how can regular plans have higher ranking than direct plans.

This is not an isolated example. ETMutualFunds.com has found that there are many similar examples where direct plans were ranked below their regular counterparts. Mutual fund advisors say this spook many DIY investors.

“DIY investors, in general, do not check the performance of a direct fund specifically. When it comes to choosing a scheme, they simply check the rating and ranking of the regular plan of a scheme and invest in the direct option of the same scheme,” says Ankita Tanna Narsey, founder, Oaktree Financial Advisors.

Should such a difference in ranking really worry you? No, say most mutual fund advisors. The star-rating reflects the ranking of scheme within the category. The regular plans are ranked according to their position among the regular plans in the same category, whereas direct plans are ranked based on their position among direct plans.

“If the regular plan of a scheme is doing better than regular plans of other schemes in the category, it will be ranked accordingly. But, the same performance might not reflect in the direct plan of the scheme when compared to the direct plan of the funds in the category. They are basically comparing regular to regular and direct to direct,” says Chokkalingam Palaniappan, Director, Prakala Wealth Management. “The rating agency can show the rankings and ratings for regular and direct plans separately to erase the confusion for DIY investors,” he adds.

Still confused? For example, the regular plan of a scheme could be in the first quartile among regular plans, while the direct plan of the same scheme could be in the second quartile among direct plans in the same category. This would result in five-star ranking for the regular plan, and four-star ranking for the direct plan.

“It is better for DIY investors to check the performance of a regular plan as they have a much longer track record available than their direct counterparts. Apart from returns, you must check fund manager’s experience and performance of the fund in different cycles as well. This will reflect in the rating of a regular plan as it has existed for much longer than its direct plan. The scheme’s portfolio is same for its regular and direct plan,” says Palaniappan.

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