FUND FULCRUM (contd.)

December 2014

Regulatory Rigmarole

Fund houses have started complying with SEBI’s seed capital norm which requires them to invest in their own funds. Earlier in February 2014, SEBI board had approved a long term policy for mutual funds in which it had asked AMCs to invest 1% of the amount raised (subject to a maximum of Rs.50 lakh) in all open ended schemes during its life time as seed capital. The market regulator had asked fund houses to comply with this diktat by May 05, 2015. Fund houses are supposed to invest in both equity and debt schemes. While some fund houses like DSP Black Rock, Mirae, and Birla Sun Life have started putting seed capital in their open equity funds, majority of AMCs are yet to catch up. The concept of seed capital is prevalent in overseas markets. According to Investment Company Institute, an association of U.S. investment companies, US investment companies are required to have at least $100,000 of seed capital in each new fund before distributing its shares to the public; this capital is usually contributed by the sponsor or adviser in the form of an initial investment. It remains to be seen if this regulation proves effective for investors in the days to come.

In a bid to expand the reach of stock exchange mutual fund platforms, SEBI has permitted exchanges to accept non-demat transactions from investors. Now brokers can scan and send documents to stock exchanges just like the way Funds India and Prudent operate. Stock exchanges had approached SEBI to allow investors who do not have demat accounts to transact via the stock exchange platform. The move comes over one year after SEBI allowed mutual fund distributors to use stock exchange infrastructure for mutual fund transactions through demat accounts in October 2013. This was a major hurdle for exchanges in expanding the reach of mutual funds. Now, investors do not have to incur the costs associated with maintaining a demat account. After the entry loads were abolished, SEBI nudged stock exchanges to create a mutual fund platform with a hope that the distributors would find it a cost effective and convenient way to carry out mutual fund transactions. SEBI has recently permitted exchanges to give limited membership to distributors to use stock exchange platform at a marginal fee. Hence, BSE launched its StAR MF Platform in 2009. NSE too launched its NSE Mutual Fund Service System (MFSS) around the same time.

SEBI has clarified that individual research analysts associated with registered brokerages and fund managers of mutual fund houses would not require a separate registration under the latest guidelines regulating research analysts. The move follows representations made by brokerages, asset management companies and law firms, seeking clarity on the applicability of the new guidelines. The new norms called Securities and Exchange Board of India (Research Analysts) Regulations, 2014 took effect on 1 December, 2014. Among other things, it states that entities and individuals wanting to recommend stocks as research analysts need to get registered after meeting the prescribed criteria regarding qualifications, capital adequacy, establishment of internal policies and procedures, firewalls against conflict of interest, sufficient and timely disclosures, among others. Individuals employed as research analysts with a registered entity are not required to obtain a separate registration certificate. The research entity which employs individuals as research analysts is, however, required to get a registration under the new regulations. SEBI has given six months’ time for entities to get registered. Further, SEBI has clarified that the definition of research report in the latest norms does not include comments on general market trends, broad-based indices, economic, political and market conditions. Periodic reports or other communications prepared for unit holders of mutual funds or alternative investment funds, or clients of portfolio managers also will not fall under the category. Statistical summaries of financial data of a company or technical analyses on demand and supply in a particular sector or index too are exempted from the scope of definition of research reports. The new regulations would not be applicable on investment advisors, credit rating agencies, portfolio managers, asset management companies, fund managers of alternative investment funds or venture capital funds. Taking a strict view, SEBI has also clarified that the regulator can take penal action against erring research analysts in the form of cancellation of registration or debarment. Technical analysts, who earlier had one-page recommendation notes issued multiple times a day, will now have to come out with a full-fledged report each time they respond to the market on an intra-day basis.

AMFI has shot off a letter asking AMCs and distributors to update the missing information of investors who had done Know Your Client (KYC) before January 1, 2012­­. AMFI has also asked them to seek only additional documents from such investors. The investors who had undergone KYC registration before January 1, 2012 will have to be asked to provide additional information. This includes name of father/spouse, marital status, nationality and gross annual income/latest net worth, etc. In addition, the investors will have to go through personal verification. In a few instances, the KRA system shows invalid KYC for investors. However, there is no specific information on missing documents. AMFI had taken up the matter with the KRAs, who have confirmed that the issues have been addressed and resolved. On checking the websites of the KRAs, it is observed that all KRAs are now showing details of the missing information. Besides, AMFI has attached the SEBI guideline on KYC in which the market regulator had clarified that individual investors who had completed KYC before January 1, 2012 with CVL will have to submit additional KYC details along with in personal verification. The regulator had told distributors that such updates can be done by using ‘KYC Details Change Form’. However, corporate investors who had done KYC before January 1, 2012, have to undergo fresh KYC by submitting the necessary documents.

The capital market regulator has plugged the loophole that allowed savvy mutual fund investors to lower tax by bonus stripping. The Securities and Exchange Board of India has spelt out that it is not in favour of fund houses launching new schemes with bonus option in their arbitrage funds. The regulator has told some of the asset managers that it will not give the go ahead to these schemes if they are filed for approval. Investors are misusing this for tax avoidance purpose. Most of them are big investors and not retail investors. The bonus option involves an investor selling the original units for a loss and holding on to the bonus units which are sold later to realise long-term capital gains. For instance, in a 1:1 bonus issue, the investor who holds 100 units receives another 100 units. Under the tax laws, the cost of the bonus units is considered as zero. Since the net assets of the scheme remain the same and only the number of unit increases, the net asset value (NAV) drops proportionately. Investors then sell the original units at the reduced price and set off losses against capital gains in other assets. The accumulated bonus units are treated as tax free after a year since arbitrage funds are treated like equity funds for tax treatment. In addition, SEBI rules say bonus units are not subject to exit load.

To re-energise the mutual fund industry, SEBI plans to set up an expert panel to suggest measures for increasing distribution of mutual fund products through digital modes such as internet and mobiles. The panel, a sub-committee of SEBI’s Advisory Committee on Mutual Funds, will look into various options and steps required to boost the penetration of mutual fund products through use of digital channels for their sale. The new panel is also likely to suggest steps to enhance the online investment facility and tap the internet savvy users, especially the youth, to invest in mutual funds. It will also suggest ways to tap burgeoning mobile-only internet users for direct distribution of mutual fund products. According to an estimate, number of internet-enabled mobile phones in the country is expected to increase from 10-15 millions in 2010 to 300-400 millions in 2015. The Securities and Exchange Board of India is of the view that a greater use of internet as a distribution channel can help increase the penetration of mutual funds, especially among young investors. As per the regulator, the online phenomenon is growing rapidly as more and more people, especially the younger generation, prefer to carry out most of transactions online such as internet banking, shopping, and ticketing. At present, many fund houses are offering facility for online investment, but industry insiders say that there is a need to promote and make it more user friendly for investors by improving the infrastructure and efficiencies. Nearly 45 fund houses together manage assets worth around Rs 11 lakh crore in India, but fund mobilisation has been a tough task for them in the past few years. One of the biggest reasons behind this low fund mobilisation is the lack of healthy participation from a large part of the country. A SEBI conducted study had said that mutual fund presence in the country is heavily skewed in favour of the top 60 districts of India. Out of 60 districts, a lion's share of the mutual fund presence originates from Mumbai as the city houses the headquarters of most of the large companies, thereby getting a bulk of investments through the non-retail or institutional routes.

FUND FULCRUM

December 2014

The asset base of the mutual fund industry dropped by Rs 5,344 crore to Rs 10.90 lakh crore in November 2014 mainly on account of outflow from the 'money market' segment. The country's 45 fund houses together had an average AUM of Rs 10,90,309 crore at the end of November 30, 2014, down from Rs 10,95,653 crore in the preceding month, according to the data by Association of Mutual Funds in India (AMFI). The AUM data for individual fund house is not being disclosed. The monthly decline in AUM is largely on account of withdrawal from money market or liquid segment to the tune of Rs 52,460 crore during the month. Overall, mutual funds saw a net pullout of Rs 25,628 crore. The assets managed by mutual funds had crossed Rs 10 lakh crore mark for the first time in May 2014 on the back of a sustained rally in markets after the formation of a new government at the Centre.

According to the Securities and Exchange Board of India data on total investor accounts with 45 fund houses, the number of folios rose to 3.99 crore at the end of November 30, 2014 from 3.95 crore in the last fiscal (2013-14), registering a gain of 3.54 lakh. Growth is mainly on account of addition in equity fund folios, which was supported by sharp rally in the stock markets. Besides, the fund houses have clocked Rs 1.55 lakh crore net inflows in various schemes during the April-October period. The BSE Sensex surged by around 28% during the period under review on the back of hopes of economic reforms and heavy capital inflows. The equity category saw addition of more than eight lakh folios to over 3 crore investors at the end of October 31, 2014. The segment saw first rise in folios in the month of April 2014 after reporting a consistent decline in investor accounts in the past four years.

Thanks to inflows in existing schemes and new fund offers, equity mutual funds received net inflows of Rs. 4,963 crore in November 2014. A large part of the inflows came in existing funds (Rs. 9,282 crore) while new fund offers mopped up Rs. 1,014 crore. Investors pulled out Rs. 5,548 crore from equity funds, which resulted in net inflows of Rs. 4,963 crore (includes ELSS figures). Since the beginning of FY 2014-15, equity funds have seen positive inflows each consecutive month. So far, the industry has attracted inflows of nearly Rs.45,000 crore in April-November 2014. The AAUM of equity funds crossed Rs.3 lakh crore mark in November 2014 on account of mark to market gains and fresh inflows. The total AAUM of equity funds stood at 3.15 lakh crore as on November 2014. The Sensex rallied over 28,600 levels in November 2014 which boosted investor confidence in equities. AMFI data shows that four new close end equity funds were launched in November 2014 which collectively mopped up Rs.1,014 crore. Reflecting the positive sentiment among investors, equity funds saw an addition of over 1 lakh folios in November 2014. SEBI data shows that the total number of equity folios has crossed 3 crore in November 2014. Income funds saw net inflows of Rs. 18,844 crore in November 2014 on expectations of interest rate cut by RBI. In October 2014, the category witnessed inflows of Rs. 15,446 crore. Gilt funds, which saw continuous outflows in the recent past, witnessed inflows of Rs. 814 crore. A few fund houses had recently come out with gilt funds with maturity of 10 years. However, in the debt category, liquid funds saw net outflows of Rs.52,460 crore in November 2014. Gold ETFs continued to see redemption pressure as the category saw net outflows of Rs. 32 crore in November 2014. Meanwhile, other ETFs, which track the equity indices, received inflows of Rs. 492 crore in November 2014. Overseas fund of funds saw net outflows of Rs.128 crore in November 2014. Last month, overseas FOFs had witnessed a net outflow of Rs.49 crore. There are 31 international funds in the industry which manage Rs. 2,819 crore. All in all, the industry saw a net outflow of Rs. 25,628 crore largely on account of outflows from liquid funds.

The five biggest fund houses clocked 27% growth in net profit in the first half of 2014-15 compared to the same period last year. These five fund houses account for nearly 54% of the total AUM the mutual fund industry. UTI Mutual Fund has not been included because its half yearly results are not out. In addition, the figure for Reliance Mutual Fund is the gross profit before tax. The largest fund house HDFC Mutual Fund retained its position as the most profitable asset management company. However, ICICI Prudential Mutual Fund has witnessed the fastest growth in profitability, with its H1 net profit rising from Rs 81 crore in the previous year to Rs 123 crore in 2014-15. ICICI Prudential Mutual Fund has shot past Reliance Mutual Fund to become the second-largest fund house in the country. In the past one year, its AUM has increased by 50%. However, even Reliance Mutual Fund reported a sharp 41% rise in its gross profit in the first half of this year and a 31% rise in its AUM.

Retail participation in mutual funds from beyond the top 15 cities in the country has increased 33% in the past 18 months, due to joint efforts made by the mutual fund houses and stock market regulator SEBI, says AMFI. The mutual fund industry's assets under management (AUM) crossed Rs 1,07,000 crore from retail investors living in places beyond the top 15 cities as on October 31, 2014. As on March 31, 2013 the AUM was Rs 65,000 crore, according the Association of Mutual Funds in India. The AUM relate to equities, equity-linked saving schemes (ELSS) and the balanced funds which essentially involves retail participation. Besides, mutual fund houses adopted several districts on a voluntary basis which also attracted investors from smaller towns towards mutual funds.

Piquant Parade

Japanese life insurer Nippon Life is set to increase its stake in Reliance Capital Asset Management (RCAM) to 35%. Currently, Nippon holds 26% stake in RCAM. The company will invest Rs. 657 crore in the current financial year to acquire an additional 9% in RCAM. The Japanese insurer can increase its stake to 49%, subject to necessary regulatory approvals. However, it will take nearly 2 years to reach this limit due to compliance issues. The company has reached a definitive agreement with Reliance Capital for raising Nippon Life’s ownership in Reliance Asset Management. 

Mutual fund houses are getting innovative in talking about the benefits of investing in mutual funds in their investor awareness programs (IAPs). UTI Mutual Fund and Axis Mutual Fund have recently launched their audio visual campaign on social media. A few months back, Birla Sun Life ran a similar campaign called ‘Janoge tabhi toh manoge’ which aimed at busting the myths associated with mutual funds. Fund houses are promoting their campaigns through social media platforms like YouTube, Facebook, twitter, and whatsapp. UTI Mutual Fund launched a campaign called ‘Haq, ek behtar zindagi ka’ (Right to lead a better life) to mark its 50th anniversary. The first commercial went on air on November 11 on Youtube and other social networking websites. In its latest commercial, it tries to touch the emotional chord of people by showing a son fulfilling his father’s dream. Axis Mutual Fund has released a 2.28 minute long video which is aimed at raising awareness about tax saving through mutual funds. 

The National Stock Exchange has launched a pilot version of its platform called MF Simplified for mutual fund distributors. The platform will be launched within a month. In fact, the company has started demonstrating the product feature to distributors. The platform will provide investors a common account number which can be used to invest across AMCs. Around eight AMCs have signed up with the platform. This common number will enable distributors and their clients to submit multiple requests across schemes of various fund houses using a single application. Moreover, the platform will provide online transaction facility to investors as well as distributors. Distributors can get direct membership on this platform and transact directly on the stock exchange platform under their own ARNs. This means that mutual fund distributors will get commissions directly from AMCs. To get membership on NSE’s new platform, distributors have to shell out a onetime processing fee of Rs. 2,500 along with a refundable deposit of Rs.15,000 (for individuals and others) while corporates have to pay Rs. 25,000. In addition, members have to pay an annual renewal fee of Rs. 2,000. This is the second platform being designed especially for IFAs. Its old platform ‘Mutual Fund Service System (MFSS)’ will continue to function. NSE has tied up with CAMS to develop this platform.

…to be continued

NFO NEST

December 2014

NFOs of various hues continue to flood the market in the December 2014 NFONEST.

ICICI Prudential Growth Fund – Series 5

Opens: December 1, 2014

Closes: December 15, 2014 ICICI Prudential Mutual Fund has launched a new fund as ICICI Prudential Growth Fund - Series 5, a close ended equity fund. The tenure of the fund is 1279 days from the date of allotment. The investment objective of the fund is to provide capital appreciation by investing in a well-diversified portfolio of equity and equity related securities. The fund will invest 80% - 100% of its assets in equity & equity related instruments with medium to high risk profile and invest up to 20% of assets in debt, money market instruments, and cash with low to medium risk profile. Investment in securitized debt can be up to 50% of debt allocation of the fund. The benchmark Index for the fund is CNX Nifty Index. The fund is proposed to be listed on BSE. The fund will be managed by Vinay Sharma and Yogesh Bhatt. The investments under ADRs/GDRs and other foreign securities will be managed by Shalya Shah.

Indiabulls Arbitrage Fund Opens: December 1, 2014 Closes: December 15, 2014

Indiabulls Mutual Fund has launched a new fund as Indiabulls Arbitrage Fund, an open ended equity fund. The investment objective of the fund is to generate income by predominantly investing in arbitrage opportunities in the cash and derivative segments of the equity markets and the arbitrage opportunities available within the derivative segment and by investing the balance in debt and money market instruments. The fund shall invest 65-100% in equity and equity related securities, 65-100% in equity derivatives and up to 35% in debt & money market securities/instruments. The benchmark index for the fund will be CRISIL Liquid Fund Index. The fund manager will be Sumit Bhatnagar.

DWS Midcap Fund - Series I

Opens: December 1, 2014

Closes: December 15, 2014

Deutsche Asset Management India has announced the launch of DWS Mid Cap Fund- Series 1, a three year close ended equity fund.  The objective of the fund is to generate long term capital appreciation from a portfolio that comprises equity and equity related securities of mid cap companies. The fund portfolio will comprise 70% - 100% of mid-cap companies.  The equity fund management team is led by Akash Singhania. The benchmark index for the fund will be CNX Mid Cap. The fund managers are Akash Singhania and Rakesh Suri.

HDFC Capital Protection Oriented Fund – Series III

Opens: December 5, 2014

Closes: December 17, 2014

HDFC Mutual Fund has launched a new plan named as HDFC Capital Protection Oriented Fund- Series III - December 2014, a close ended capital protection oriented scheme with the duration of 1207 days from the date of allotment. The investment objective of the plan is to generate returns by investing in a portfolio of debt and money market securities which mature on or before the date of maturity of the fund. The fund also seeks to invest a portion of the portfolio in equity and equity related securities to achieve capital appreciation. The plan would invest 75% to 100% of assets in debt and money market instruments with low to medium risk profile and invest up to 25% in equity and equity related instruments (including equity derivatives) with high risk profile. Benchmark Index for the plan is CRISIL MIP Blended Index. The fund managers are Anil Bamboli (Debt Portfolio) and Vinay R Kulkarni (Equity Portfolio). Rakesh Vyas will be dedicated fund manager for Overseas Investments.

Reliance Capital Builder Fund II - Series A

Opens: December 8, 2014

Closes: December 17, 2014

Reliance Mutual Fund has launched a new fund as Reliance Capital Builder Fund II - Series A, a close ended equity oriented fund with the duration of 1102 days from the date of allotment. The investment objective of the fund is to provide capital appreciation to the investors, which will be in line with their long term savings goal, by investing in a diversified portfolio of equity & equity related instruments with small exposure to fixed income securities. The fund will allocate 80%-100% of assets in diversified equity & equity related instruments with medium to high risk profile and invest up to 20% of assets in debt and money market instruments with low to medium risk profile. The benchmark Index for the fund is S&P BSE 200 Index. The fund managers will be Samir Rachh and Jahnvee Shah (overseas investments).

UTI Focused Equity Fund Series - II

Opens: December 4, 2014

Closes: December 18, 2014

UTI Mutual Fund has launched a new fund as UTI Focused Equity Fund Series - II, a close ended equity fund with the duration of 1102 days from the date of allotment. The primary objective of the fund is to generate long term capital appreciation by investing predominantly in equity and equity related securities of listed companies. The fund will endeavor to invest in either growth stocks or value stocks or both without any capitalization bias. The fund will normally hold up to 30 stocks in the portfolio. The fund will allocate 65% to 100% of assets in equity and equity related instruments with high risk profile and invest up to 35% of assets in debt & money market instruments with low to medium risk profile. The benchmark Index for the fund is S&P BSE 200 Index. The fund managers will be Anoop Bhaskar and Lalit Nambiar. Arprit Kapoor is the dedicated fund manager for investments in ADRs/GDRs/Foreign Securities.

Baroda Pioneer Equity Trigger Fund

Opens: December 5, 2014

Closes: December 19, 2014

Baroda Pioneer Mutual Fund has launched a new fund as Baroda Pioneer Equity Trigger Fund - Series I, a close ended equity fund. The investment objective of the fund is to provide capital appreciation by investing in a well-diversified portfolio of equity and equity related securities predominantly of mid-cap and small cap companies. The fund shall invest 80-100% in equity and equity related instruments with medium to high risk profile and up to 20% in debt, money market instruments and cash with low to medium risk profile. Equity instruments: (1) Investment in mid-caps can be between 65% - 100% (2) Investment in small-caps can be between 0% - 15%  (3) Investment in large-caps can be between 0% - 15% (4) Investment in equity derivatives can be up to 50% of the net assets of the fund. The units of the fund will be listed on NSE in order to provide liquidity. The benchmark Index for the fund is S&P BSE Mid-cap index. The fund manager will be Dipak Acharya.

ICICI Prudential Capital Protection Oriented Fund – Series VII Plan C

Opens: December 10, 2014

Closes: December 24, 2014

ICICI Prudential Mutual Fund has launched a new fund named as ICICI Prudential Capital Protection Oriented Fund VII - Plan C, a close ended capital protection oriented scheme. The tenure of the scheme is 1284 days. The investment objective of the fund is to seek to protect capital by investing a portion of the portfolio in highest rated debt securities and money market instruments and also provide capital appreciation by investing the balance in equity and equity related securities. The securities would mature on or before the maturity of the plan under the fund. The fund would allocate 70%-100% of assets in debt securities and money market instruments with low to medium risk profile and invest up to 30% of assets in equity and equity related securities with medium to high risk profile. The fund is proposed to be listed on NSE. Benchmark Index for the fund is CRISIL MIP Blended Index. The fund managers are Vinay Sharma (equity portion), Aditya Pagaria and Rahul Goswami (debt portion) and Ashwin Jain (for investments in ADR/GDR and other foreign securities).

Baroda Pioneer Hybrid Fund Series 1 and 2, Axis Retirement Planning Fund, Reliance US Equity Opportunities Fund, Sundaram Select Small Cap Fund Series III and IV, UTI Medium Term Fund, HSBC Capital Protection Oriented Fund Series II (Plan 1 to Plan IV), HDFC Focused Equity Fund, BOI AXZ Capital Protection Oriented Fund Series 3, and Sundaram World Brand Fund-Series IV-VI are expected to be launched in the coming months. 

GEMGAZE

December 2014

Average investors need a balanced investment portfolio in order to earn reasonable returns at an acceptable level of risk. This is achieved by investing money in debt funds besides diversified equity funds.

All the GEMs from the 2013 GEMGAZE have performed reasonably well through thick and thin and figure prominently in the 2014 GEMGAZE too. 

ICICI Prudential Long-term Gilt Fund Gem

Launched in August 1999, ICICI Prudential Gilt Investment Fund sports an AUM of Rs 809 crore. Being a gilt fund, the credit quality of the portfolio is very high with Government of India securities constituting 96.84% of the total assets. There are six holdings in all with an average maturity of 16.25 years and yield to maturity of 8.1%. The fund earned a return of 16.94% in the past one year as against the category average of 15.89%. The expense ratio is 1.06%. The fund is benchmarked against the I-SEC Li-BEX index. The fund is managed by Mr. Rahul Goswami and Mr. Anuj Tagra.

Canara Robeco Income Fund Gem

Canara Robeco Income Fund was launched nearly a decade ago in 2002. The current AUM of the fund is Rs. 166 crore with 11 holdings. Central Government loan constitutes 61% of the total assets, bonds 9%, debentures 19%, and commercial papers 11%. The credit quality of the fund is reasonably high. The interest rate sensitivity of the fund is high with the average maturity at 10.7 years and yield to maturity of 8.46%. Its return in the past one year is 13.79%, almost on par with the category average of 13.1%. The expense ratio of the fund is high at 1.9%. The fund is benchmarked against the CRISIL Composite Bond Index. The fund is managed by Mr. Avnish Jain since June 2014.

Birla Sunlife Dynamic Bond Fund Gem

Birla Sunlife Dynamic Bond Fund manages assets worth Rs. 10,025 crore. This fund is a steady top quartile performer with low volatility. It has delivered returns across interest-rate cycles and is among the top few in its category. The one-year return of the fund is 14.23% as against the category average of 13.10%. In the last five years, Birla Dynamic Bond Fund has generated compounded annual returns of 9.19%, putting it among the top couple of funds in its category and ahead of peers such as SBI Dynamic Bond, Kotak Flexi Debt, and BNP Paribas Flexi Debt. The number of holdings in the fund’s portfolio is 52 with an average yield to maturity at 8.39%. The expense ratio is 1.21%. Maneesh Dangi is the fund manager since September 2007.

 

Birla Sunlife Government Securities Long term Fund Gem 

Launched in October 1999, the fund has an AUM of Rs 415 crore. The one-year return of the fund is 16.76% as against the category average of 15.89%. The fund is benchmarked against the I-Sec Li-Bex. The fund has eight holdings with the yield to maturity of 8.35%. The expense ratio of the fund is 1.72%. Prasad Dhonde and Kaustubh Gupta have been the fund managers since October 2012. 

Birla Sunlife Floating Rate Short term Fund Gem

This relatively young fund, launched in October 2005, boasts of a massive AUM of Rs 2991 crore.  In the past one year, this liquid fund has returned 9.11% as against the category average of 8.78%. The number of holdings in the fund’s portfolio is 33 with an average yield to maturity at 8.62%. The expense ratio is a mere 0.3%. The fund is benchmarked against the CRISIL Liquid Index. Sunaina da Cunha and Kaustubh Gupta are the fund managers.

FUND FLAVOUR

December 2014

If you are buying a debt fund to give your portfolio stability or to help generate income, then your strategy may pay off. Investing in debt mutual funds usually entails less risk and less reward than investing in equity mutual funds. But debt funds, like any other mutual fund, do involve some degree of investment risk. Liquid funds, ultra-short, short term, intermediate, and long term are various categories that do not perform alike or carry the same risks. For instance, instruments in the portfolios of liquid funds have a maturity period of less than 91 days. Hence, the interest rate risk does not exist to the extent it does in long-term debt funds. Moreover, the fund managers tend to stick to a high credit rating to maintain a very high quality portfolio which makes it less susceptible to default risk. Linked to the above is liquidity risk. If the fund manager invests in poorly rated paper, it could turn into a liquidity risk. A fund faces liquidity risk if the fund manager is not able to sell his paper due to lack of demand for that particular security. Liquidity risk is high in funds with a portfolio of low credit quality. No market-related investment is risk free, be it equity or debt. While debt funds are not as perilous as equity funds, these are the risks that they carry.

New kid off the block…

To discourage investors from buying gold, RBI launched inflation index bonds which were meant to provide a hedge against inflation. After RBI launched these bonds in 2013, DWS, HDFC, and SBI have launched their Inflation Index Bond Funds which exclusively invest in these bonds. Axis Mutual Fund too has filed an offer document with SEBI to launch its inflation index bond fund. Inflation Indexed Bonds (IIB) are issued by the Government and have coupon and principal linked to inflation. Having a tenure of 10 years, these bonds are linked to the Wholesale Price Index (WPI). For instance, if these bonds are available at an yield of 3% above WPI, and WPI for the full year is 7%, IIB will offer a coupon rate of 10 % (7%+3%) during that year.  

Not only do these bonds offer safety of principal, but they can also offer capital appreciation if the rate of inflation increases. These bonds are ideal for risk-averse investors since they are backed by the government and are as safe as other sovereign bonds. On the flip side, fixed deposits and tax-free bonds are better alternatives to IIBs. Tax free bonds provide fixed interest throughout the term. Contrary to this, the return from IIBs is dependent on the rate of inflation. IIBs are treated like debt funds for taxation. These bonds are suitable for investors falling in the lower tax bracket (up to 10%). The demand for these bonds is low mainly because of lack of awareness. About 10% to 20% of your portfolio can be allocated towards these bonds.

Norms to strengthen the base

SEBI observed that many debt oriented schemes are operating with a very low AUM. It is of the view that it is imperative that debt oriented schemes have an adequate corpus to ensure adherence to the investment objectives as stated in the Scheme Information Document and compliance with investment restrictions specified under SEBI (Mutual Funds) Regulations, 1996. Hence, it has mandated fund houses to have a minimum subscription amount of at least Rs 20 crore in the case of debt oriented and balanced schemes at the time of new fund offer and at least Rs 10 crore in the case of other schemes. An average AUM of Rs 20 crore on a half-yearly rolling basis has to be maintained for open ended debt oriented schemes. AMCs will have to report the compliance of this regulation to SEBI in the Half Yearly Trustee Reports. If the above cannot be maintained, the AMC will have to scale up the AUM of such a scheme within 6 months so as to comply, failing which the scheme will be wound up.

Debt funds underperform

In terms of returns to investors, most of the debt-based mutual funds in the country underperformed compared to their respective S&P benchmark indices, over the last five years, according to the report by S&P Dow Jones Indices. The comparative analysis between debt-based funds and S&P India's two benchmark indices -- government bond index and bond index -- is for the five years ended June 2014. According to the report by S&P Dow Jones Indices, more than 78% mutual funds in Indian government bonds failed to beat S&P India Government Bond Index, while 53% Indian Composite Bond funds were outperformed by S&P India Bond Index. The interest rate remained higher and impacted the active managers in the Indian government bond peer group which underperformed the S&P India Government Bond Index over one, three and five-year periods. Almost a quarter of the funds in this peer group disappeared over the five-year period. Active managers in the Indian composite bond category also could not outperform the benchmark in the five-year period.

Advantages unearthed

Debt funds offer several advantages but small investors know little about them and fail to keep abreast of what is happening on the debt fund front. Here are the salient points for consideration:

Tax rules have changed

There are three things proposed in the 2014 budget that are negative for investors in debt funds.

a. Investors have to hold a debt fund for 36 months, to get any benefit of long-term capital gain (LTCG).  Currently this number is 12 months.

b. The choice of paying taxes at 10% without indexation on LTCG is no longer available. LTCG from non-equity oriented funds would be taxed at 20% tax after indexation.

c. Dividends distributed by mutual funds are subject to dividend distribution tax (DDT). This will now be paid on the gross basis and not on net amount of dividend paid.

FMPs with tenure less than 36 months, redeemed after April 1, 2014, will no longer be eligible for indexation benefits, or lower long-term capital gains tax.  The redemption proceeds will be subject to tax at the marginal rate of tax of the investor (plus surcharge and cess).

There might be a slight advantage in opting for dividend option for a holding period of less than three years, if the investor falls in the 30% bracket.  This is because dividend is subject to dividend distribution tax (DDT) at 25% for individual investors.  For investors whose tax rate is lower than 25%, growth option is better than dividend option, since their STCG will be taxed at their marginal rates of taxation. The rate of DDT is flat 25% and hurts investors with tax rate lower than 25%. Investors in bank deposits only have to pay TDS (10%). They may also be able to claim some refunds.

No tax deduction at source

A tax-friendly feature of debt funds is that there is no tax deduction at source (TDS) on the gains. In fixed deposits, if your interest income exceeds Rs 10,000 a year, the bank will deduct 10.3% from this income. If you are not liable to pay tax, you will have to submit either Form 15H or 15G to avoid TDS. The other problem is that the income from fixed deposits is taxed on an annual basis. You will get the money once the deposit matures, but the income is taxed every year. In debt funds, the tax is deferred indefinitely till the investor redeems his units. In addition, the gains from a debt fund can be set off against short-term and long-term capital losses you may have suffered in other investments.

Returns are market-linked

Though they are looking very promising, debt funds do not offer assured returns. In fact, they can also churn out losses in case the interest rates go up, although the possibility of this happening is remote. The maturity profile of the holdings defines the volatility of a debt fund. Funds holding short-term bonds are not very volatile and give returns roughly equivalent to the prevailing interest rate. But the funds that invest in long-term bonds are more sensitive to changes in interest rates. If rates decline, the value of bonds in their portfolio shoots up, leading to capital gains for the investor. While the average short-term debt fund has given 9.8% returns in the past year, some long-term bond funds have shot up by 14-15% during the same period.

Keep in mind the exit load

A debt fund is very liquid since you can withdraw your investments at any time and the money is in your bank account within a day. However, some funds levy a penalty for exiting before the minimum period. The exit load can vary from 0.5% to 2%, while the minimum period can range from six months to up to two years. Check the exit load of the fund before you invest. Even a 1% exit load can shave off a significant portion from your gains.

Create SIPs in equity fund via debt fund

If you have a large sum to invest, invest it in a debt fund and start a systematic transfer plan to the equity fund of your choice. Every month, a fixed sum will flow out from the debt fund into the equity scheme. Compared to the 4% your money would have earned in the savings bank account, it has the potential to earn 9-10% in the debt fund. Similarly, if you want regular retirement income from your investment, invest in a debt fund and start a systematic withdrawal plan. Every month a fixed sum will be redeemed from your investment.