The removal of the indexation benefit from long-term debt funds will affect future flows but gives an incentive against redemption of existing schemes. In an interview to FE’s Siddhant Mishra, Kotak AMC’s Managing Director Nilesh Shah says the amendment won’t really translate to an advantage for banks, but calls for a level-playing field in terms of taxation across instruments. Edited excerpts:
Following the move to remove indexation benefit, what will be the impact on flows into debt funds?
This has provided a powerful incentive to not redeem existing schemes but complete the three-year terms and avail of the tax benefits. There will be no impact on the AUM as of March 31, but future flows into three-year-plus duration funds will be impacted.
In addition, there are other factors at play. If returns from alternatives like equity are high, or if systemic liquidity is tight, flows into the three-year-plus bucket will automatically reduce.
What proportion of debt funds is likely to see a hit?
We’re looking at close to 35% of the overall debt AUM.
In what way will the bond market be affected?
Our size is smaller than banks, insurance firms, and pension funds in the medium-to-long duration bond markets, but we’re more innovative. It was MFs that created a floating rate in India, at a time when it was unknown to most people.
The ability to innovate reduces with a reduction in flows, and to that extent the bond market deepening will be affected.
How will this change the dynamics of investments by corporates, HNIs, and family offices?
They will likely gravitate towards instruments providing tax benefits, such as ULIPs and zero-coupon debentures. Some money will flock to credit AIFs, which are pass-through vehicles.
Supposing one invests Rs 100 — earning Rs 10 in coupon and Rs 5 in capital appreciation — the Rs 15 gain will be taxed according to the slab rate in the case of MFs. In the case of AIFs, the Rs 10 will be taxed as interest income, and the balance Rs 5 as short-term capital gains. This differential in tax treatment could impact flows.
You have called for a level-playing field in terms of taxation concerning zero-coupon bonds. What changes could be considered?
There are three conditions, provided you sell. First, it should be zero-coupon; second, it should be listed; third, it should be traded for the interest to be considered capital gains.
Since MFs are being taxed at slab rates, the same should apply to all other instruments. Suppose one purchases gold directly and holds it for three years, it will considered LTCG and they get indexation benefit. But when you invest in an MF that buys the same gold, there’s no indexation benefit. So, should people buy gold directly or invest via MFs?
Listed zero-coupon bonds will be over Rs 1 trillion, and a 10% interest translates to Rs 10,000 crore. With a 25% tax arbitrage, there is a Rs 2,500-crore loss to the government. Taxing MFs will fetch you Rs 1,000-1,500 crore, depending on the assumptions you make. Plugging gaps in the former should have been the priority.
Do banks hold a clear advantage now?
Even the SBI chairman has said that banking and MFs are complementary services. For instance, let’s assume the banking system has Rs 100. Deducting Rs 4 (CRR) and Rs 18 (SLR), it will lend from the balance Rs 78. The borrower deposits the same in another bank, which once again deducts the CRR and SLR requirements and lends from the balance, a concept we know as the money multiplier. However, if one invests the same amount in an MF, via the banking system, the entire Rs 100 is available for investment. So the money multiplier is higher in an MF. Therefore, banks won’t benefit/lose by money getting in or out of MFs.
For banks, systemic liquidity remains the same whether the money comes into banks or MFs. For lenders, it is about FD vis-à-vis CASA.
Do you see investors moving more towards shorter-tenure schemes or overnight/liquid funds as the sheen from long-duration funds wears off?
An investor’s horizon won’t change because of a different taxation structure. From a fund house’s perspective, the percentage of flows in various categories will change, but not from an investor’s point of view.
Could you share the challenges AMCs are facing following reforms by the regulator and proposals made?
The regulator discusses any potential reforms with fund houses before proceeding. While there might be differences in the manner of execution, our views are always taken into consideration. In terms of challenges, it is important to note that we’re not activist shareholders. However, that doesn’t mean we’ll be silent spectators to irregularities. We have, in the past, voted on executive remuneration to make it performance-linked, on royalty payouts, and against steps that we believed were against the interests of minority shareholders.