The small percentage of small investors

The mutual fund sector is crying foul over a Budget announcement to change the tax provisions for the debt-oriented funds

The mutual fund sector is crying foul over a Budget announcement to change the tax provisions for debt-oriented funds. The finance minister doubled the capital gains tax payable on redemption of such funds to 20 per cent. Confusion remains as officials go back and forth on the effective date. Either way, the move is the most significant since the ban of entry loads five years ago and has the potential to alter the course of the Rs 9-lakh-crore sector.

The minister explained the rationale,"The capital gains arising on transfer of units held for more than a year are taxed at a concessional rate of 10 per cent whereas direct investments in banks and other debt instruments attract a higher rate of tax. This allows tax arbitrage opportunity. This arbitrage has hardly benefited retail investors as their percentage is very small among such mutual fund investors."

Let us examine the last sentence, which seems a justification for the move. Figures from the Association of Mutual Funds of India (Amfi) for the quarter ended March show retail investors indeed account for a 'small percentage' of the debt fund corpus - 6.6 per cent to be precise. But, this number does not tell the entire story. Debt-oriented funds, which form the single largest group of the Indian mutual fund sector, account for Rs 4.6 lakh crore, or over half of the sector's assets. This means retail investments in these funds total a not-so-small sum of Rs 30,706 crore.

Let me complicate this further. Mutual funds have a system of folios, which gives a rough number of investors in each category. It is rough because one investor can have multiple accounts. Amfi figures showed these debt-oriented funds had 5.8 million retail folios (average investment of Rs 53,000 per folio). Even if one discounts for duplicate folios, the number is by no means small. And in terms of number of folios, retail investors accounted for 88.94 per cent of debt oriented funds. So, the argument that retail investors did not benefit from these products seems a little weak.

One comparison that can tilt the balance in the favour of the minister's argument is the retail investor share of equity-oriented funds. Retail investors accounted for Rs 1.27 lakh crore or 66.51 per cent of the funds under equity category. With 28.64 million accounts, they also had 98 per cent share of folios.

This is where the sector has to take the blame. Traditionally, funds have encouraged their agents to sell risky equity funds, which earned them higher fees, to small investors. The corporations and high net worth individuals, who won't fall for such sales talk, got themselves parked in debt funds, where they enjoyed what the minister has now termed "tax arbitrage."

Thus, the agents and the funds, driven more by their own profit motives than the consumer interest, wooed most small guys away from debt funds to riskier equity funds. The smart small guys, who saw through these and put their thousands in safer, tax-savvy debt funds, were crowded out into a 'small percentage' by the arbitrage-hungry corporations and wealthy investors, who pumped their millions into these vehicles. The small guys did not cause any of these, yet became collateral damage. As you know, the attack is on arbitrage and small guys are only a small percentage.