Mutual funds may knock on Sebi door for hybrid fund tax stimulus

Conservative hybrid schemes can invest a max 25% in equity; industry wants limit enhanced to 35%

The mutual fund (MF) industry may make a representation to the Securities and Exchange Board of India (Sebi) to increase the equity investment limit in conservative hybrid funds from 25 per cent to 35 per cent, according to two people aware of the development.

If the proposal goes through, conservative hybrid funds will regain the tax advantages they lost due to changes in debt fund taxation in Union Budget 2023-24.

Raising the equity allocation to 35 per cent would mean the scheme would qualify for long-term capital gains tax (LTCG), under which gains are taxed at 20 per cent with indexation benefits.

The tweak in structure will make conservative hybrid funds a differentiated investment offering with tax efficiency and lower risks.

The Association of Mutual Funds in India said it has not sent any such proposal to Sebi as of now. 

Although such an offering (debt-heavy fund with tax advantage) is possible through other fund categories like balanced advantage and multi-asset, most large fund houses do not have this opportunity since they have equity-focused funds in these categories.

Other fund houses are exploring these opportunities.

Recently, WhiteOak Capital MF launched a multi-asset fund which will maintain domestic equity exposure of 35-65 per cent. The rest of the investment will mostly be in debt and gold.

The change in taxation has created three different tax structures for MF schemes, depending upon their equity and debt exposure.

Any scheme with less than 35 per cent allocation in domestic equities is taxed at a marginal tax rate, while those with 35-65 per cent equity allocation still come with LTCG tax advantage and allow indexation benefits.

Funds with over 65 per cent equity allocation are taxed as equity schemes in which gains are taxed at a flat rate of 15 per cent after a year. Capital gains of up to Rs 1 lakh in a year are tax-exempt.

Apart from optimising the debt-equity allocation in new schemes, MFs are looking at options like raising credit and duration risks within permissible limits and bringing in cost efficiencies to lower expenses to maintain the competitiveness of debt schemes.

The other possibility is the management of debt funds more actively, according to experts. This would entail fund managers making timely shifts in the duration of portfolio, consistent with market conditions, and identifying safe but lower-rated papers to improve returns.

Increasing investment in high-yield real estate investment trusts and infrastructure investment trusts is another option on the table.

The change in taxation of debt funds has come as a challenge for MFs in their quest to increase market share. Debt funds are the closest to bank fixed deposits, which have traditionally received the highest chunk of household savings. MFs have been seeing a rise in share in household savings. In the financial year 2022, MFs had recorded a 150 per cent jump in gross inflows from retail investors. Still, the share of MFs in total gross savings was just 6.3 per cent.

Points to Ponder

• MFs are looking at options like raising credit and duration risks within permissible limits
• WhiteOak Capital MF launched a multi-asset fund where equity exposure will be between 35% and 65%
• Funds with over 65% equity allocation are taxed at 15% after a year
• Increasing investment in REITs and InvITs is another option