Excess sectoral exposure is bad for portfolio

FUND QUERIES

I have invested in five systematic investment plans (SIPs) in November, 2007 with the investment horizon of 1 year. However, in the past 10 months, the net asset values (NAVs) of all these funds have dipped sharply. Kindly advice whether I should switch over to some other fund or hold on to these. My funds include JM Basic, Tata Infrastructure, UTI infrastructure, DSP ML TIGER Growth and ICICI Prudential Infrastructure fund.

-Deeda

All your money is invested in infrastructure funds, including JM Basic and DSPML TIGER. The equity markets only went up till January and infrastructure stocks were the top flavour. But since the decline, stocks and funds in this sector have taken a severe beating. Given the deteriorating economic environment, the immediate and medium-term outlook for this theme remains weak.

The long-term outlook, however, remains promising. So, it is advisable that you gradually move your entire money to one or two diversified equity funds and continue your SIPs in those. Investing in the market through any downturn has important benefits in the long run because the NAVs go up faster when there is a turnaround.

Considering that I fall in the highest income bracket, is it better to put money in short-term fixed maturity plans (FMPs) with the dividend payout option or liquid fund's dividend payout option? What are the taxation rules applicable to FMPs (both short and long term). Do short term FMP, which offer dividend payout option, declare and pay dividend in-line with the yield declared before the maturity date or do they delay it for a later date?

- Chandresh Rawka

The dividend income of both liquid fund and FMPs are subject to Dividend Distribution Tax (DDT). But DDT on liquid funds is more than FMPs. While FMPs attracts DDT of 14.16 percent, liquid funds attract DDT of 28.32 percent.

The treatment of long-term and short-term capital gain is similar for liquid funds and FMPs. The short-term capital gain is taxed as per marginal rate applicable to the investor, while long-term capital gain is taxed at 10 per cent without indexation or 20 per cent with indexation, whichever is lower.

It would be more tax efficient to park your money in a dividend option of an FMP, which suits your time frame, rather going for a liquid fund.

Clearly an investor in the highest tax bracket is better-off in the dividend option.

Do mutual fund investors get the benefit of bonus shares and dividends? Also, when the portfolio is switched by fund manager, how is the cost (brokerage, securities transaction tax and short-term capital gains tax) passed on. Are these expenses met through entry and exit load?

Jayprakash Chavan

All benefits in the form of dividend, bonus share, right issues, interest and gains on all investments accrue to the fund and reflected in the NAV.

From the income tax point of view, it is exempted from paying tax on gains accrued due to normal process of business, such as short term capital gains tax and long term capital gains tax. The other expenses incurred by the fund can be classified into two broad heads - transactional expenses and operational expenses. All these expenses are charged to the fund and ultimately passed on to the investors.

The transactional expenses include brokerage and securities transaction tax. Such expenses are incurred on a day-to-day basis on buying and selling of securities. They are deducted from the NAV of the fund on a daily basis.

The operational expenses of a fund include management fees, custodian fees and audit fees. These expenses are met through the expense ratio, which are also adjusted on the daily basis from the NAV of the fund. The upper limit for expense ratio differs for different types of funds. It is 2.50 per cent for equity funds, 2.25 per cent for debt funds, 1.5 per cent for index funds and 0.75 per cent for fund of funds.

I have invested in only one equity fund in tranches. I want to know that if I redeem some of the units now, which units will be considered as redeemed and how will the capital gain be calculated? Will the First In and First Out (FIFO) method be used for calculating the capital gains? Please clarify.

-Ajay Chandna

Yes, FIFO method will be used for calculation of capital gains on the redeemed units. When you redeem your investment, the units which are bought first would be assumed to be redeemed first, then the units bought in the second lot and thereafter.

Please advise whether investment switched from an ordinary equity fund to Equity Linked Savings Scheme (ELSS) fund would be eligible for computing deductions under section 80C of that year?

-Arvind Chandorkar

Yes, you can also take 80C benefit in same financial year by switching from equity fund to ELSS fund. But if your tenure of investment in equity fund is less than a year then you have to pay short term capital gains tax while you switch.

Value Research