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Debt mutual fund tax changes to hit fund houses, say analysts

The Rs 40 trillion asset management industry was taken aback by the government’s decision to end the tax breaks that debt mutual funds (MFs) received in comparison to bank fixed deposits (FDs).


The somewhat late change in tax collection set off an auction in AMC stocks, with obligation store market pioneer HDFC AMC falling north of 4%. Both Aditya Birla Sun Life AMC and UTI AMC saw their stock prices decline by more than 4%.

“For us, this move is disruptive. One of our most important selling points for debt schemes has been the indexation benefit. “The efforts being made to deepen the bond market will also be harmed by this change,” Deputy MD DP Singh of SBI MF stated.


“There will no longer be tax arbitrage between bank FDs and debt MFs in the future, which has been a major draw.” This could decrease the amount of money flowing into debt mutual funds. According to Chirag Mehta, CIO-Quantum AMC, “in addition, funds such as gold ETFs and any funds that fall under the category of debt funds for the purposes of taxation may also see a drop in inflows.”


Debt funds, which already have a small number of non-institutional investors, have been the subject of concerns due to the change in taxation, which has led some investors to switch to bank FDs. Asset management companies (AMCs) are likely to see a decline in revenue as a result of this lack of inflows.


The only fund house that only manages debt funds, Trust MF, anticipates that changes in taxation will have an effect on flows into debt funds in the long run. In the short term, there probably won’t be any effect, but in the long run, it might affect mutual funds’ ability to attract credit flows. According to Trust MF CEO Sandeep Bagla, funds that are able to actively manage their portfolios and generate returns for investors that exceed inflation will gradually receive the flow.


Given the ideal obligation value blend, a few experts expect a “medium to low effect” on shared assets’ incomes.


“We believe this to be a medium to low impact as the majority of revenue/profitability for AMCs is generated from equity AUM and non-liquid debt AUM is neither a high growth nor a high profitability segment,” the CLSA stated in a report. Are.”


The brokerage estimates that non-cash credit schemes contribute between 11 and 14 percent of the AMC’s total revenue.


Cash schemes are referred to as liquid and overnight funds due to their high liquidity and safety.


Due to the fact that their investors never really benefited from the preferential taxation, the tax change may have little effect on the Ultra Short Duration, Low Duration, and Money Market debt schemes, which have short duration funds. The majority of investments in these products are made for the short term, and tax benefits begin after three years have passed.


In February, cash and short-term debt schemes accounted for Rs 8.6 lakh crore, or 62%, of the industry’s total loan assets under management (AUM) of Rs 13.4 lakh crore.


Debt fund managers, according to experts, can lessen the effect on inflows by increasing the performance of active schemes and decreasing the costs of passive schemes.


“This will force debt MFs to work harder to generate alpha, and will benefit passive MFs like targeted maturity funds, roll-down funds, and fixed maturity plans (FMPs),” stated Somnath Mukherjee, CIO and Senior Managing Partner, ASK. will cut expenses.” private assets


Firoz Aziz, Deputy CEO of Anand Rathi Wealth, anticipates that the new tax system will encourage innovation in debt mutual funds. “He added that AMCs can modify their debt offerings to include equity and arbitrage, thereby lowering investors’ tax payments.”


Although the new law eliminated the long-term capital gains tax on debt funds, hybrid schemes with a portfolio that contains more than 35% equity will still be eligible for preferential taxation. This 35% equity exposure can come from equity, arbitrage, or a combination of the two.


Because the managers only hold equity positions and generate returns from the difference between the prices of stock futures and the underlying stock, the arbitrage strategy is taxed as equity but carries fewer risks.


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