From April 1, new investors in debt funds will no longer get the indexation benefit for holding schemes for more than three years — something that has come as a blow to the Rs 40-trillion mutual fund industry. No wonder, fund houses are going back to the drawing board in order to deal with the surprise move by the government last week. With the discontinuation of the indexation benefit to funds of over three-year duration set to hit 35% of the assets under management (AUM) under debt schemes, industry players say new products are the only way out.
Said Marzban Irani, CIO, fixed income, LIC MF: “While fixed deposits are considered safer, it requires a lock-in, with the interest taxable above Rs 40,000. However, MFs are more liquid and are transparent, with disclosures on portfolio every 14 days.”
“We may see the advent of new products such as balanced debt funds, or a hybrid fund with 35% allocation to equity/arbitrage, thus skewing it in favour of fixed income. There will be a focus on the tax angle as that’s what attracts investors, even though investment products should be sold based on requirements and proper awareness,” he added.
Innovation is the only way ahead, and fund managers will now have to don their creative hats and introduce products such as dynamic bond funds and conservative hybrid funds. Another senior executive at a fund house agrees, saying that investors could now tilt towards more actively managed open-ended schemes.
“This seems to be a balancing act by the government, by saying that income-only instruments should be treated as such. This was in view of the stress that the insurance sector was reeling under, following the tax on policies of above Rs 5 lakh premium,” said the MD and CEO of a fund house who did not wish to be named.
In the Rs 39.5-trillion mutual fund (MF) industry, AUM of debt funds stands at close to Rs 13 trillion. Of this pool, around Rs 4.5 trillion is likely to feel the impact of the amendment to the Finance Bill passed last Friday.
“Fund houses, though smaller players than insurance firms, banks and pension funds in the medium-to-long duration bond market, are far more innovative. This industry launched the floating-rate funds in India,” Kotak AMC’s managing director Nilesh Shah had told FE in an earlier interview.
He pointed out that while future flows are likely to take a hit in this category, there may not be an immediate change in AUM, given that there is now an incentive for investors to hold on to schemes and complete their entire tenure before they lose the indexation benefit.
Importantly, the amendment applies to gold funds and international funds as well. The MD and CEO cited above pointed out that investing in international funds is a different ball game, because of which the decision comes as a surprise.
Further, this clearly makes investing in sovereign gold bonds a more attractive proposition, with indexation no longer a boon. “It’s expensive to hold the yellow metal in the physical form, so SGBs will be the clear answer. Gold ETFs will be taxed at the slab rate, which makes them unattractive. SGBs are backed by the government, providing the confidence of security.”
According to some experts, tax shouldn’t be the sole objective in making investment decisions. Citing the example of ULIPs and endowment plans, fund managers say these plans are made attractive highlighting the tax benefits, but that’s not the purpose, as investment decisions should be based on one’s requirements and capacity.
“For investors, indexation provided an added advantage as it discouraged redemptions before three years. Now, people may book profits and exit before three years as there is no motivation to stay invested. The benefit should have remained at least till the debt market becomes as vibrant as the equity market,” said the debt fund head.
After the passage of the Finance Bill, DP Singh, deputy MD and CBO of SBI
Borrowing costs for NBFCs, as a result, are seen rising as there could be an increased dependency on banks, though the impact may be limited.
According to a report by Jefferies, with debt MFs funding at 10-11% of corporate bonds, corporate bond yields may inch up amid moderation in debt inflows. The report added that the preference for more liquid non-convertible debentures — owing to the uncertainty around the holding period for debt MF investors — could affect credit spreads.
Jefferies’ estimates suggest MFs fund close to 15% of NBFCs’ corporate bonds. As of February 2023, MFs’ investment in NBFCs’ corporate bonds (ex-PSU) stood at Rs 2.5 trillion.