Mf Scheme As Savings Account

I never did like close-ended pure-growth schemes of mutual funds (MFs), especially those which had managed to collect a large corpus from investors, for the following reasons:

1. Imagine the impact when Mastergain-92 and Morgan Stanley Growth Fund are redeemed. When scrips, most of them blue chips, worth thousands of crores, are forced to be sold it will spell disaster for the share markets and, consequently, for the Indian economy.

2. At redemption, the investor has to willy-nilly pay tax and reinvest the remaining funds, possibly in similar schemes and, possibly, of the same fund which just terminated the old scheme. This is a national wastage. The launch expense itself is around 6 per cent of the total amount collected. Longer the term, lesser is this indirect tax because the overheads of the launch get spread over a longer period.

 

The rate of indirect tax on long-term capital gains in the hands of the investor drops sharply since the cost inflation index is a direct function of the holding period. To avoid this, some MFs offer a roll over (Mastershares and Candouble) whereas some offer to switch over (Mastergain-92).

3. At that point of time, good schemes may not be available and the investor will be forced to invest in B or C class avenues.

4. Securities and Exchange Board of India (SEBI) required (note the past tense) very reasonably all those close-ended schemes to be listed to provide liquidity to the investor, especially during the lock-in period. The sharks in the market had been (again note the past tense) taking undue advantage of this stipulation by managing to hold the prices at a heavy discount over the net asset value (NAV). The ruses applied were many. The main one was mudslinging through news items and articles with vested interests. If repurchase facility is provided directly from the MF which is what the open-ended plans do, all liquidity problems are solved.

Open-ended pure growth schemes: The main and possibly the only reason of existence of an MF is to protect the investor from going to the market directly. Then is it logical to force him to go to the market for selling units?

SEBI has been studying these predicaments since rather too long. In June last year, its executive director, Mr Pratip Kar, had invited me to discuss the various corrective actions that could be taken. The main thrust of our discussion was the necessity of converting a close-ended scheme into an open-ended one and allowing the MFs to borrow funds, especially to cater to repurchases and not for the purpose of leverage.

SEBI has not allowed close-ended schemes to become open-ended under specific conditions. It should have taken these actions long ago but being an arm of the government it is saddled with a bureacratic regime. Often regulatory actions are taken in a hurry, possibly without enough home work, while corrective actions are taken after rigor mortis has already set in. I sincerely hope that the time lag has not already killed the MFs.

It is UTI, the big brother, which has once again taken the first step and decided to convert two flag-ship close-ended schemes, Mastergain-92 and Grandmaster into open-ended ones from January 1, 1997 and August 1, 1986 respectively.

Now, the investors will not have to worry any longer about the sharks. One can now deal with UTI directly, either for sale or repurchase.

Mastergain-92 and Grandmastmer are now virtually all of these: Savings bank pass book: The open-ended schemes have become, ipso facot, savings bank deposits with much higher returns and much lower taxes. You can deposit and withdraw partially or fully any time.

Pension scheme: It is possible to convert such pure-growth schemes into monthly/ regular income schemes merely by asking for partial repurchases on monthly (or quarterly or half-yearly or yearly) basis.

Crisis management: Many persons keep large sums in their savings account for catering to unforeseen calamities. These schemes can now provide the same facility.

Gift: Units upto Rs 30,000 can be purchased every year and gifted to dear ones.

Children's gift and growth: These units can be purchased in the name of a child of any age and encashed only when the child becomes a major. The clubbing provision can be easily bypassed thus.

Anytime liquidity: SEBI has insisted that the fund shall settle repurchase requests within 10 working days. Most of the funds are revamping systems and procedures to enable the fund to make the payment sooner. As a matter of fact, some MFs pay across the counter in metro cities.

A tax slash: A holding period of over one year attracts the concessional tax treatment on long-term capital gains. Yes, Central Board of Direct taxes (CBDT) has given an opinion that when the bonds are redeemed or repurchased by the issuing company itself, it cannot be treated as capital gains. But the investor is on stronger ground in case of units of UTI/MFs since the rate of growth is not known a priory.

Even if it is treated as interest, it has to be realised that a large portion of such withdrawals is capital and tax has to be paid only on the difference between the amount withdrawn and the orginal cost of acquisition. This allows investors to have a large amount for expenses and yet pay little tax, if any. The growth on the portion not withdrawn is not taxed on accrual basis and there is no tax deduction at source (TDS) on this amount.

Once this is understood, I do not think that any taxpayer will invest in avenues other than open-ended pure-growth schemes of UTI/MFs. These are also good for a non-taxpayer. Where else will one get such an attractive income with high safety and liquidity? These are also ideal parking places even for those who do not pay any taxes thanks to a muddled thinking that the rates are very high and so it is advantageous to evade them rather than legally avoid them.

Past performance: Past achievement is no guarantee for future success. Similarly a lack-lustre performance in the past does not necessarily mean that the future will continue to be dull. An enlightened investor will realise that an equity-based fund has its fortunes linked with the market's. When the market falls heavily the fund is also bound to fall. If the fund-fall is not as heavy the investor will give credit to the management.

Unfortunately, it has become fashionable to point an accusing finger at financial institutions though they are not responsible for the bottoming of the market. But I am absolutely certain that given time, the investors will regain their faith.