With the markets rising once again from the lows of mid-June, many retail investors would be tempted to put in large sums of money at one go, which may increase the chance of losses if the markets correct suddenly. If you have earned a lumpsum amount, say a hefty bonus after two years of Covid-induced pay-cut, and want to shield the amount from market swings, opt for a systematic transfer plan (STP) of mutual funds.
In this, you can invest the lump sum amount in a debt fund, preferably ultra-short-term bond fund, and then regularly transfer —monthly or quarterly —a specific amount into an equity fund so that the entire fund is not exposed to the volatility in the market. An STP will enable a disciplined and planned transfer of funds between two mutual fund schemes and will have twin benefits.
For one, the amount of money parked in the source fund will earn higher returns than a savings bank account. Second, the equity portion of the fund can earn higher returns over the long-term and the investor will get more units when markets fall and less when markets are rising which will average out the rupee cost and balance the investment among liquid and equity portfolios.
Experts say STP can be a good way to mitigate market risks, help cap losses and increase investors’ portfolio returns in the long term. The period of the STP will depend on the investor’s financial goals. However, investors should ideally go for a longer-duration STP into an equity scheme as it would give higher returns in the long run if invested systematically.
What type of STP to choose?
Asset management companies offer various types of STPs such as capital appreciation, variable and fixed. In capital appreciation, only the capital returns generated from the source fund are transferred to the destination fund. This type is gaining popularity as the markets were very volatile, especially since January this year. Alternatively, an investor can set up an STP mandate to book profits regularly from an equity fund and transfer the amount to a debt fund to mitigate the market volatility. It can even work well for retirement planning, where a fixed amount of money can be transferred from an equity fund to a debt fund over a period of time, say five years.
In a variable type, an investor can transfer different amounts from the source fund to the target fund depending on the market volatility. For example, if the net asset value (NAV) of the target fund drops due to market correction, then the amount can be increased. On the other hand, if the NAV gains because of the rise in markets, then the amount of investment can be lowered. In a fixed type, a predefined amount is transferred at the given frequency.
The source debt mutual funds in which the lumpsum is invested should have good quality paper and adequate liquidity in the market.
In a fixed income product, credit risk is the risk of default on a paper if the borrower fails to pay the principal and the interest. In case of a default, it will impact the fund to the extent of its weight in the portfolio. The risk is high for those companies which are not rated very high by credit rating agencies.Also, liquidity risk is higher in the case of corporate bonds with a low credit rating.
In case of STP, every transfer from a debt fund will be a redemption and attract capital gains tax. So, a redemption before three years will attract short term capital gains tax at the investor’s marginal rate. If the redemption is done after three years, the long-term capital gains tax will be 20% after indexation. Redemption from equity funds before one year will be taxed at 15%, and redemptions after one year will be taxed at 10% for gains over Rs 1 lakh in a financial year. So, evaluate the tax implications before setting the STP mandate.
— Set up an STP mandate to book profits regularly from an equity fund and transfer the amount to a debt fund to mitigate the market volatility
— Every transfer from an STP is a redemption and will attract capital gains tax based on the period of holding and type of fund– debt or equity
— Mutual funds offer capital appreciation, variable & fixed STP for transfer of money from source fund to destination fund