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One of India’s top 10 mutual funds in terms of assets under management (AUM), Franklin Templeton AMC has upended the industry by abolishing exit loads on investors switching from regular to direct plans of its open ended funds. The move, which will take effect from 9 May, 2019, is likely to encourage a shift in investor money from regular to direct plans. Switching one’s investment from regular to direct was till now partially impeded by exit load. Exit load is the charge levied on exiting the scheme in the initial years and is defined as a percentage of investment. It depends on how long the investor has held the scheme. The shorter the holding span, the more likely it is that exit load will be applicable.
What are regular and direct plans?
All open ended mutual fund schemes have regular and direct plans which are identical to one another, except for one key difference — distributor commissions are charged to investors in regular plans but not direct ones. So, in a regular plan, the distributor is expected to help you execute your mutual fund transactions. Distributors can also explain the features of products to clients and offer incidental advice.However some clients do not need the help of distributors and are capable of selecting and executing their own transactions. Direct plans are meant for such clients.
In 2013, The Securities and Exchange Board of India (Sebi) made it mandatory for mutual funds to offer direct plans. It also brought in a category of advisors called Registered Investment Advisors (RIAs) who could charge fees but not distributor commissions on mutual funds. This move, coupled with the growth of online investment platforms offering direct plans prompted a gradual shift among investors towards direct plans of mutual funds among some clients. Distributor commissions on average are around 1% per annum in equity funds and 0.5% in debt funds.
The shift towards direct plans has so far been gradual with most of it coming on the institutional side. According to AMFI data as of March 2019, only 17% of the assets of individual investors were invested in direct plans. The move by Franklin Templeton AMC is likely to trigger a faster shift from institutional and individual investors. Similar moves by other AMCs are likely to further speed up the shift. “This is a very bold and positive step by Franklin Templeton AMC. It gives customers the ability to choose the type of plan that’s best for them." said Suresh Sadagopan, founder, Ladder 7 Financial Advisories. “Exit load was a major mental block preventing many investors from shifting to direct plans. I welcome the move, it will put more money in investors’ pockets," added Lalit Keshre, co-founder of Groww, an online investment platform.. Groww offers direct plans on its website.
Some advisors remain cautious about other AMCs emulating the move by Franklin Templeton. “I’m not optimistic about other AMCs following suit," said Sadagopan. “Distributors are an important constituency to be taken into account by AMCs." Similar moves by AMCs may be viewed negatively by distributors who earn commissions from regular plans.
Tax issue remains
While abolishing the exit load will give investors more flexibility, a serious impediment remains as a shift from regular to direct can come with a tax implication. There is 15% (short term capital gains tax) for holding periods of 1 year or less and 10% (long term capital gains tax) for gains above ₹1 lakh per annum for longer holding periods in equity funds. In case of debt funds, tax is levied at your slab rate for holding periods of 3 years or less and at 20% for longer holding periods (along with the benefit of indexation). Even with the abolition of exit load, the applicability of tax still deter many investors from shifting from regular to direct plans.