Union
Budget 2014-15 has produced its share of diverse reactions. On Budget day, equity
markets were at their volatile best. While bigwigs from opposition parties
slammed the Budget, industry leaders hailed it. Diverging
opinions notwithstanding, one area where consensus has emerged is that the
mutual fund industry and investors have been done in by the Finance Minister
(FM).
Proposals
pertaining to long-term capital gains on non-equity oriented funds (read debt
mutual funds) and dividend distribution tax (DDT) are being seen as spoilers. To
be fair, a higher tax liability does hurt and negative reactions aren’t surprising.
But to suggest that these provisions
will spell doom for the mutual fund industry is far-fetched. Debt fund
segments such as liquid funds and fixed maturity plans (FMPs) which account for
a significant size (roughly 41% as of June 2014*) of industry assets are likely
to be most affected by the aforementioned provisions. The theory doing the
rounds is that the stringent tax provisions will result in investors shunning
these segments in favour of bank fixed deposits.
What
critics need to consider is—was the tax
arbitrage (versus avenues such as bank fixed deposits) their only draw? To
my mind, debt funds operate on the premise of offering market-linked returns
and high liquidity at low risk. Critics will argue that higher tax will result
in lower post-tax returns. That’s where the
mutual fund industry needs to step up to the plate. To begin with, fund houses
can make debt funds inexpensive by lowering costs. Then, there’s scope for
paying more attention to the investment management function.
For
instance, it is an open secret that most
FMPs operate on an auto-pilot mode with minimal intervention from portfolio
managers. To be fair to portfolio managers, given the large number of FMPs
that a typical fund house launches, there isn’t any alternative but to treat
them as mass-produced commodities. But a modified approach, wherein the number of
FMP launches is rationalized, managers invest more time and effort, coupled
with competitive costs, will keep the segment competitive even in the new
regime. It would be safe to assume that better returns will translate into
investor interest and asset flows
A
constant rhetoric from fund houses is that individual investors should use liquid
funds (roughly 22% of industry assets as of June 2014*) as an alternative to
savings bank accounts. However, it is an
indisputable fact that liquid funds continue to be a domain for corporate and
institutional investors (as of March 2014, 88% of assets in liquid funds
were held by corporates and institutions*). Why the skewed holding pattern?
It’s simple: corporates and institutions
represent a ready clientele which will bring in big monies, so fund houses are
happy to cater to them.
Conversely,
tapping into retail monies is an arduous task. To begin with, retail investors
will have to be educated and sold the idea of investing in liquid funds. Also a
smaller ticket size means that fund houses will have to reach out to a large
number of retail investors. But is it realistically possible for fund houses to
become more retail-oriented? Yes, it is, and here’s how: fund houses will help their own cause by making sensible and honest use
of the mandated investor education monies rather than plastering cities with
surrogate advertisements under the garb of investor education. In the long-term,
fund houses must reduce their unhealthy reliance on corporates for assets.
Speaking
of long-term, here’s something to cheer about. Most seem to have overlooked that the
limit for tax-saving under Section 80C has been enhanced to Rs 150,000. Equity Linked Savings Schemes (ELSS) from
mutual funds are eligible for tax sops under Section 80C. The interesting
bit is that these are equity funds (on which fund houses typically make more
money versus debt funds); additionally the investments are subject to a 3-year
lock-in from the investment date (read sticky long-term money). For cynics who
believe that ELSS will become a thing of the past when the long-awaited direct
tax code arrives, wait and watch! All recommendations of the erstwhile FM may
not find place in the new direct tax code.
The
Budget highlights mention “uniform
tax treatment for pension fund and mutual fund linked retirement plan”. In
a February 2014 press release, market regulator SEBI alluded to the mutual fund
linked retirement plan. It would be safe to assume that guidelines for such
products will be issued shortly and that mutual
funds will be able to attract retail long-term monies from such products too.
Comparable tax treatment with similar products from the insurance industry only
further sweetens the deal.
To
my mind, the Budget has done enough to
facilitate flow of long-term monies into mutual funds. The onus to make most of the opportunity on hand lies with the mutual
fund industry.
On
a related but distinct note, five years ago, around the same time, SEBI
abolished entry loads on mutual funds. Even then naysayers had predicted that
the mutual fund industry was doomed. Guess what, it’s still up and running.
Likewise even now, it would be best to take those predictions of penal tax
provisions seriously hurting the industry with a pinch of salt.
* Data sourced from www.amfiindia.com
