Multi-asset playbook divides mutual fund industry; hybrids in demand

Three recent launches opt for debt taxation, two stick to equity

The change in debt fund taxation is seen as boosting the demand for hybrid funds. It is no surprise then that asset management companies (AMCs) have launched a raft of new products in the multi-asset category.

However, they seem to be divided on the asset mix and approach.

The multi-asset space, which provides fund houses ample scope to innovate, has seen five launches in as many months.

While two of these schemes — by Kotak Mahindra and Shriram — have adopted the traditional multi-asset structure designed for equity taxation, the rest of the three schemes — by DSP, Edelweiss, and WhiteOak — have come out with new asset allocation frameworks to qualify for the erstwhile debt taxation.

The change in debt fund taxation at the end of 2022-23 (FY23) created three tax structures for mutual fund (MF) schemes. Funds holding a minimum of 65 per cent in equity qualify for equity taxation, while those investing less than 35 per cent in equity are taxed as pure debt schemes. The rest of the schemes with 35–65 per cent equity exposure qualify for the debt taxation structure that was applicable until the end of FY23 (20 per cent tax with indexation benefits for those holding the units for more than three years).

More recently, Kotak Mahindra and DSP have launched their schemes in the multi-asset category, both taking a divergent approach.

Nilesh Shah, managing director of Kotak Mahindra AMC, says the fund house evaluated both fund structures before opting for the equity set-up due to two reasons: higher return potential and the possibility to leverage the experience of managing equity-oriented multi-asset fund of funds (FoF) over the years.

“Undoubtedly, it (the debt structure) would have given us more flexibility. But based on our track record of managing multi-asset FoF for the past 19 years, we thought an equity-oriented fund could better optimise the risk and return compared to a debt-oriented fund,” he said.

DSP MF cited asset allocation flexibility with the debt taxation structure as the rationale behind its decision to opt for an innovative asset allocation framework.

“Based on our analysis, using arbitrage allocation instead of debt allocation can drag down the returns of the portfolio. When interest rates are falling, typically the arbitrage spreads also reduce, and so it reduces the overall returns,” said Anil Ghelani, head of passive investments and products, DSP MF.

Most multi-asset fund managers use arbitrage as a strategy to bring down their net equity allocation to below 65 per cent while maintaining the equity-taxation advantage.

According to analysts, the two fund structures have their own merits relative to each other. For example, equity taxation products give investor the flexibility to withdraw at any time after one year without losing the tax benefits. In the case of debt taxation, they will have to stay invested for a minimum of three years.

“In the case of debt taxation hybrid schemes, the advantage lies in their flexibility to make pure merit-based allocations,” said Arun Kumar, vice-president and head of research, FundsIndia.

The long-term capital gains tax (10 per cent for capital gains of over Rs 1 lakh) kicks in for equity funds after one year, while in debt, the minimum holding period is three years.

“While the fund suitability differs from investor to investor, the tax impact on returns is likely to be similar across schemes for those investing for the medium-to-long term (over three years),” Kumar said.

Apart from the multi-asset route, fund houses are also looking at a little-known hybrid fund category to launch funds with the former debt taxation.

On Monday, 360 ONE launched the first balanced hybrid MF scheme. WhiteOak MF has also filed papers for a similar scheme.

These will be akin to a balanced advantage fund (BAF), except that the fund manager will have to maintain a minimum 40 per cent allocation in both equity and debt. In BAFs, fund managers have full flexibility, i.e., the equity or debt allocation can range anywhere between 0 and 100 per cent.

"It (balanced hybrid) focuses on pure equity and debt assets, without exposure to arbitrage or other asset types. Some existing equity hybrid funds have limited allocation to pure debt strategies (approximately 30-35 per cent). In case of BAFs, a significant portion (40-50 per cent) of debt allocation is invested in maturities of less than one year to meet the fund's margin/liquidity requirements," said Bhavin Jatania. Head of Products, 360 ONE AMC.

However, only a few fund houses have the option to launch a ‘balanced hybrid’ fund, given that the MF regulations allow fund houses to launch only one of these two hybrid schemes: balanced hybrid and aggressive hybrid. Most fund houses already have an aggressive hybrid scheme.