DSIJ Mindshare

Non-equity Funds Set To Lose Their Sheen

The Finance Minister presented Union Budget 2014-15 before the parliament amid high expectations. Although the government has been in power for just seven weeks, the budget covered a wide spectrum of issues. The Finance Minister has laid out a vision and policies that are likely to trigger economic growth going forward. Overall, the Finance Minister did a good job and has set the stage for big reforms.

However, the Union Budget turned out to be a mixed bag for investors, especially those who invest in mutual funds. The Budget gave some relief to the middle class in the form of increase in minimum taxable limit to Rs 2.5 lakh and to Rs 3 lakh for senior citizens. Besides, investment limit under Section 80C has been enhanced to Rs 1.5 lakh. In addition, deduction limit on interest on loan in respect of self-occupied house has been raised from Rs 1.50 lakh to Rs 2 lakh.

However, there are negatives too. The Union Budget 2014-15 proposes to increase tax on long-term capital gains from 10 to 20 percent for non-equity funds. For tax purposes, non-equity funds are those that invest less than 65 percent in equity. Therefore, investors in variety of funds like liquid funds, ultra-short term and short term, medium and long-term income funds, FMPs, debt–oriented hybrid funds like MIPs and asset allocation funds will get impacted by this provision. Moreover, one will have to remain invested for a period of 36 months instead of 12 months to claim long-term capital gains benefits. This is certainly a step that would negatively impact investors who have non-equity funds as an integral part of their portfolios.

Considering that a large number of investors in our country still prefer to invest in traditional options like fixed deposits, bonds and small savings schemes as these instruments offer a guaranteed funds, there is a need to keep the tax efficiency of options like mutual funds intact to encourage them to invest in market-linked products. Although debt and debt-oriented funds are safer than equity funds, being market-linked products there is a certain amount of risk that investors take while investing in them. Moreover, considering that non-equity funds include funds that may have exposure to equity as high as 50-60 percent, it is not proper to equate them with pure debt funds.

There is some ambiguity about the date from which these new provisions will be applicable. However, if these provisions are going to be applicable from April 1, 2014, it will certainly be a setback for investors who may have invested in FMPs for a period of one year or so. Since these are closed-ended funds, investors do not even have the option to continue for another 24 months to convert short-term capital gains into long-term capital gains. Therefore, the logical thing to do would be to make these provisions applicable for the next financial year. After all, investors must be given time to realign their existing portfolio in line with the new tax provisions.

It is important to mention here that despite the proposed higher long-term capital gains and the compulsion to remain invested for 36 months, mutual funds will continue to have edge over traditional options in more than one way. First, mutual funds have the potential to provide higher returns than other instruments. Second, for those who can remain invested for 36 months or more, the tax effi ciency of return will remain.

Going forward, investors can do the following to minimize the impact of these provisions: Consider investing in arbitrage funds for a time horizon of 3- 12 months. Arbitrage funds are quite safe and are treated as equity funds for tax purposes.

Invest in debt-oriented hybrid funds like MIPs and asset allocation funds for a time horizon of three years or more to improve returns and negate the impact of higher capital gains tax. For investors who have the wherewithal to withstand the volatility to get higher returns, equity-oriented balanced funds can be a good bet

Hemant Rustagi CEO, 
Wiseinvest Advisors Pvt Ltd 

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