According to ET, the SEBI Mutual Fund Panel has suggested a transaction charge of Rs. 100 per transaction instead of an entry load:
Read the rest of this entry »The committee headed by Prashant Saran , member of the board at the markets regulator, last week nearly concluded that a Rs 100 transaction fee could be imposed on investors for every new investment that will help distributors cover costs
At Yahoo, I write on entry loads and my distaste for them at Loaded in Disfavour.
(Reproduced)
"Bring back the entry load" seems to be the cry among distributors and advisors of mutual funds, as the new chairman of SEBI, U.K.Sinha, appoints committees to look into various aspects of the regulator's functioning. Mr. Sinha was the head of UTI Mutual Fund earlier, where he had complained about the SEBI move to remove entry loads altogether in 2009 — the intermediary community now desires that he reverse the earlier SEBI decision. Read the rest of this entry »
In the Monetary policy yesterday (see longer post) RBI has said that Banks can't invest more than 10% of their net worth into liquid mutual funds.
Banks' investment in mutual funds aggregated Rs 1.11 lakh crore on April 6 against Rs 70,999 crore on January 14, according to RBI. Fund managers said over 80% of banks' money in mutual funds is in liquid schemes. The investment restriction will limit banks' surplus money coming into mutual fund schemes at Rs 30,000 crore. The total net worth of the banking system is around Rs 3.13 lakh crore as March 31, according to fund managers.
So Investment in Liquid funds = approximately 90,000 cr.
Net worth = 3.13 lakh cr. and 10% of that = 31,300 cr.
So 60,000 crore will flow out. When? Not immediately - banks are given six months to ease out the transition.
Assuming liquid funds charge 0.25% as management fees, the total loss will be around 150 crores. This may not sound like much but it is, I think, a reasonable chunk of MF profits.
Banks would put money into liquid funds which would in turn buy bank Certificates of Deposit, sometimes of the very banks they got the money from. That's circular. And because of it there is a risk that if one bank starts withdrawing a lot of money, it will hurt the liquidity and capital raising ability of other banks (since CDs will be sold and prices fall) which will also start selling their liquid fund holdings and so on.
The other reason banks might happily do this is that if they couldn't really take on exposures of certain corporates beyond a limit, they could buy liquid funds that could in turn buy the same companies' commercial paper.
The overall impact is negative for mutual funds, surely. It's negative for banks in that they need other ways to get the easy 9% they were getting from the mutual fund route. The days of easy spreads are over?
Updated 25 April 2011: Given the popularity of the post I decided to redo the data until today and see how MIPs have fared. It seems that the data I had was off by a little bit (in terms of dividends, but the results don't change too much). I'm reworking the entire post to include data till April 2011.
Mutual funds have monthly income plans – MIPs – that provide a monthly dividend; how do these compare against Fixed Deposits (FDs)?
First, note that MIPs are not risk free – they invest a little in equities as a “kicker”. So if you’re looking for ultra risk-free return, this is not it. I’m just looking at it as something that a retiree or semi-retiree can invest in, and doesn’t mind the slight additional equity risk. A lot of people I know would qualify.
Let’s take a 25 lakh investment made in an MIP – HDFC’s Long Term MIP Monthly Dividend plan is what I chose. Compare it with the same amount invested in a Fixed Deposit (FD) yielding 9% (Okay, no one gives 9% a year on FD monthly income, but let me be aggressive).
Taxation: Dividends on MIPs are tax-free; FD Interest is taxable. I’ve assumed a 20% tax. (Note, however, that about 13.6% of dividend distribution tax applies to mutual funds , including surcharge and cess, but this is paid by the mutual fund, not you. It reflects in the NAV.
Nowadays banks deduct 10-20% tax at source for FD interest – so if you get a lower tax rate you have to ask for a refund. That is crazy for someone who’s investing for a monthly income!
Returns: I plotted the four-year graph (assumed started on Jan 1,2007) of the entire return. The line graphs are the return-to-date for MIP and FD (including interest/dividend post tax) and the bars are the monthly income levels.
The return (blue and red lines) are the simple interest on the FD - since we require income, I assume no reinvestment of either the dividend or the FD interest.
The purple and green bars are the cash-flows every month.
Cash flows: The FD interest is constant, as expected (a net yield of 7.2%). The Monthly Income Plan has wayward income but you see the equity kicker give spiky income, but they seem to cap themselves at the lower end to what FDs would give.
The FD income, post tax, is about 15,000 per month, while the MIP dividend which is tax-free anyhow, is about 13,000 per month. However the difference is more than made up by the huge change in
MIPs seem to generate slightly higher income in parts – sorta like getting a bonus every once in a while.
| Concept | MIP | Fixed Deposit |
| Current Value if Sold | 27.65 lakhs | 25 lakhs |
| Total Dividend/Interest Received (Post Tax) | 7.78 lakhs | 7.20 lakhs |
| Total Return | 35.43 lakhs | 32.20 lakhs |
The MIP has done well in the last four years - an effective yield of 7.70% versus 7.02% for the FD (this is assuming interest and dividends were not reinvested).
But the last one year has seen a flattening down, because the equity markets haven't done too well and the long term debt market's suffered on account of rising interest rates. Also FD rates are up to 10% now and interest rate slabs have been rejigged so your eventual tax liability with a 25 lakh deposit should be at 10% - that brings the FD return much closer to the MIP.
Liquidity wise: both the FD and MIP are liquid (you can get money out in a few days). The FD carries a penalty for early withdrawals though, and the HDFC MIP has a 1% exit load for the first year.
On the face of it, with the higher risk, the MIP seems like a useful option for someone with a large corpus and wants a higher monthly income. And lesser tax reporting hassles or refund issues.
Considering tightening liquidity in the markets and the fact that I expect equity markets to hurt with rising rates, I would expect the FD to outperform the MIP but only if you are in low interest rate slabs and looking primarily for income. If you are in a higher tax slab, then a short term debt fund is likely to do better (even a short term MIP) If you're okay with keeping your money in for a year and then manually withdrawing money for cash flow each month, you could choose a growth plan and make higher returns because you don't get that 13% dividend distribution tax hit.
Finally, if you're already invested, moving to a different plan has a cost, that the new instrument will have a lock-in, work that out in your calculations before you move.
Note: Other options – tax free bonds that yield around 6.5% to 7.5%, Government 10 year bonds that yield a taxable 7.5% or corporate 10 year debentures that yield 10% or so. Some of these have monthly options too; and may be even better.
In an email, [Name withheld on request] asks:
I was reading recently about rule change in March 2010 forbidding equity funds from paying dividends out of the unit premium reserve. My understanding is that dividend payments have come down after this and the popularity of dividend paying funds has declined (would you agree with this?) I can see two explanations for this.
One is that investors somewhat irrationally chased dividends before the rule change and some fund companies took advantage of this by paying large dividends to attract flows even though the dividends did not signal actual returns.
Another explanation is that investors used these high paying dividend funds for dividend stripping.
Which of these explanations is more prevalent? Are there certain fund companies that actively tried to attract investors by paying large dividends out of unit-premium reserve versus other companies that did not do this? I am looking for examples where it is easy to tell that investors were really fooled by dividends as opposed to just the dividend stripping (if you can think of any such examples that would be great).
This is a brilliant question. First,
Units start off as Rs. 10 of "face value". If it goes up to Rs. 12, and a new person buys, then Rs. 10 goes to the unit itself, and the Rs. 2 is a "premium". The Rs. 2 per unit goes into the premium reserve.
Because it amounts to paying off one unitholder by getting money from another unitholder. Let me explain.
Assume there are just 1000 units in a mutual fund at Rs. 25 each, for an AUM of Rs. 25,000. Let us say it only sold units at Rs. 10, so there is no unit premium reserve. So the "distributable surplus" is actually Rs. 15,000 (The Rs. 25,000 minus the Rs. 10,000 of the face value of the 1,000 units)
Let us say that the fund declares Rs. 12 (or "120%") as dividend.
Now another person comes in before the dividend date, and buys another 1,000 units at Rs. 25.
We have:
Total AUM: Rs. 50,000 (original 25K plus new 25K)
Unit Capital: Rs. 20,000 (It's a face value of Rs. 10 per unit for 2,000 units)
Unit Premium Reserve : Rs. 15,000 (this is the new person's 25K minus his unit capital of 10K for 1000 units; or, the Rs. 15 premium per unit)
Distributable Surplus: Rs. 15,000 (A surplus doesn't change when new units are only bought).
Now there are 2,000 units and the dividend is Rs. 12 per unit. So Rs. 24,000 needs to be paid out as dividend, half of it to the original investors, and half of it to the new investor.
So the fund will have to dip into the "unit premium reserve" to pay the remaining 9,000. At some point this is stupid, because you are using the new investor's money to pay him dividend right back. And since people are attracted to dividends, they'll pile on without realizing this.
In Stocks, companies don't issue fresh stock. If you buy, you buy from someone else, the total number of shares outstanding doesn't change. (Yes, you might argue that the company can do an IPO in between. In any case, companies can't pay dividend from premium reserves, so the point is moot)
But SEBI decided to ban the practice precisely because it was being used by small funds to shore up AUM. (Full Circular)
Take Birla Sun Life Tax Relief 96. It's a tax saving fund, and your money is locked in for three years, while you get a tax benefit (upto Rs. 100,000).
In November 2006, the fund had just Rs. 59 cr. in assets, and the NAV was Rs. 194. They decided to informally tell distributors to attract customers saying they would pay out Rs. 100 (or 1000%) as dividend over the next four months. (Read: Birla Sun Life Tax Relief 96 - beware of dividend pushers!)
Think about it, even if they had the full Rs. 184 (the NAV of 194 minus Rs. 10 face value) as "Distributable surplus", that would make about 57 crores of distributable surplus. Note that figure, we'll need it later.
They announced one dividend in December 2006, of Rs. 25 per unit, and then another in January 2007 at Rs. 26 per unit. And then on March 16, 2007, they announced another Rs. 50 per unit.
They would give out a total of Rs. 101 out of the original NAV of Rs. 194. More than 50%.
Note: for each dividend, the NAV will fall by the same amount. (See this video) So in December you'd see the NAV fall by Rs. 25, in Jan by another Rs. 26 and so on; in end March it would end up being less than 100.
By this time, because of salivating distributors (remember, this was before entry loads were banned) the fund AUM had increased to 300 crores!)
As you can see, the AUM in December 06 went up to nearly 200 crores, which expanded to 300 crores by March 07.
Take just March 2007: They paid out Rs. 50 per unit (which was about 1/3rd the then NAV of around 140 per unit) Since they paid out 1/3rd of their corpus, they paid out Rs. 100 crores in March 2007 alone. In December they would have paid around 10 crore, and in Jan 07, around 30 crores.
That adds up to Rs. 140 crores (and I think I'm underestimating the payout) of dividend paid out.
But they started with a distributable surplus of just Rs. 57 crores! (see earlier)
What they did was to take the fresh money coming in and give it back to investors.
This is a great way for an ELSS scheme to work, because you put in the money for the tax benefit. But it's all locked in for three years! To avoid that, the fund pays out money as dividend, and voila, you get the tax benefit for the whole amount, and lock in only a part of it.
(See: Dividends in ELSS funds have an advantage)
Not anymore. Since SEBI has said it can't. What it actually generates as a surplus, it can distribute. That means it has to invest and make a profit to distribute. Which makes sense.
Ah, yes.
Yes, and they continue to do so in regular equity funds. Not that we can make out much now, but I still hear of distributors pushing clients to put in money ahead of a dividend. In tax saving funds, though, there was a rationale - that it gave them a tax saving alternative without locking in money.
Dividend stripping is not tax efficient - the tax department does not allow it anymore. (The loss on selling after the NAV falls is not considered if it's bought and sold within three months of the dividend)
I don't know. In general dividends are more attractive for shorter term debt funds for their tax advantage. In equity funds, the dividend option is used as an automatic profit booking mechanism. I haven't checked to see if the dividend option has seen lesser interest.
Hope that helps!
Some advertisements recently give the impression that you can "Demat" your mutual funds! Yippee! So you should buy through a stock broker on an exchange!
But this is a stupid reason.
Mutual funds are "dematerialized" anyway.
Materialized means that the unit certificate that you have is the be-all and end-all of your ownership; in the past, shares were sold as certificates. When you sold, you gave your certificate to the broker, who would find a way to get it over to the new buyer. If you lost your certificate, you were in deep doo-doo. You had to file an FIR and hope you had a photocoyp and beg and plead and offer your children as guarantee to get your shares back. Many instruments - NSCs for one - are like this.
Dematerialized means what you get in paper is an account statement, that your holdings are really maintained electronically. If you lose your statement, no big deal, you just call them and they send you a new one. You might need some details, but usually they can find your holdings with a PAN number nowadays. Shares are now usually held in demat mode, with demat "depositories" like NSDL and CDSL accounting for a major part of all share holdings in India.
Mutual funds are dematerialized anyhow. Even if you buy through your neighbourhood agent. Mutual fund "registrars and transfer agents" like CAMSOnline keep an electronic record. If you lose your certificate, nothing is lost. You can still redeem, buy more, get dividends etc. You don't have to buy through a stock broker. Buying through a stock broker makes your holdings go into your demat account.
To understand, visit www.camsonline.com and click on "online services for investors". As for an ActiveStatement, given only your email id. You will get an account of all CAMS maintained funds that you have ever bought in history, just like that, on email.
Stock brokers charge 0.50% for buying and selling funds. Further, most demat accounts have a fixed cost per year (about Rs. 400) and then they charge you Rs. 15 or so per transaction. That's idiotic at various levels because selling or holding mutual funds comes with next to no risk to either of them, but they choose not to reduce the cost for you. Thieves.
Today, a local agent is cheaper - your cost to go with him is Rs. ZERO, since there's no entry load. You would be much better served by doing that or hey, buying directly from the mutual fund itself. Don't fall into some stupid argument by companies which throw money at advertisements, that owning mutual funds in demat accounts is better. It is not.
Now for an interesting hidden (i.e. not yet spoken about) aspect of the budget.
According to the finance bill, any income distributed by debt funds to companies (or anyone other than an individual) will get hit with dividend tax of 30%.
Earlier the rate was 25% for liquid funds and 20% on other funds. Now it's all been bumped up to 30%, presumably to remove the discrepancy with fixed deposits.
For a while I thought: Why? If companies choose the growth option, they don't have to take on dividends - but then, if they sell the growth option funds, they get hit with short term capital gains tax on the gains, which is basically 30% (since it's added to their income). And to gain any benefit they need to hold the funds for a full year or more (in the growth option) which only a few will do.
Individuals (and HUFs) will continue to pay 25% on liquid funds and 12.5% on other debt funds.
This is a negative for MFs in general; more than 80% of all mutual fund assets are in debt funds. They have been able to provide good returns to companies who have large, but short-term corpuses. If a company had kept 100 crores for a month in a dividend paying debt fund, and it got in about 8% a year, the post-dividend tax yield would have been 6.4% on which there would be no further tax. A fixed deposit yielding the same 8% would have given them a yield of 5.6%. Now, both options are equal.
Of course, for the short term, current debt fund yields are SO much better that it still makes sense to go with MFs. Short term MFs are yielding upwards of 8% a year, and a one month FD is still offered at 4 to 5%. But that gap should narrow in the next six months.
At MarketVision, our latest video in the Mutual Fund series on: Equity Mutual Funds.
See it here. (Video, 10 min)
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