Last-minute dash for debt mutual funds before tax advantage vanishes

Target maturity funds, longer-duration schemes see high demand

Debt mutual fund (MF) schemes registered a surge in inflows in the final days of March before the new taxation rule kicked in on April 1. Investors rushed to lock in yields in mid- to longer-duration debt funds ahead of a change in the taxation structure that will see indexation benefits for the calculation of long-term capital gains (LTCG) on debt MFs not available for investments made on or after April 1.

“Inflows were a lot higher in the last few days as investors wanted to benefit from the erstwhile taxation regime,” said Radhika Gupta, managing director and chief executive officer, Edelweiss Asset Management.

Investment advisors said they had recommended clients to invest in debt after the tax change announcement, given only a few days were left to lock in higher yields, along with a tax advantage. Fund houses, too, had handed out fliers to investors to invest in debt MFs to avoid a higher tax burden.

“Investors waiting on the sidelines for yields to harden made the investment. Target maturity funds and longer-duration funds generated maximum interest,” said Anand Vardarajan, business head–banking, alternate products, and product strategy, Tata MF.

Starting April 1, investments in debt MFs will be taxed as short-term capital gains, irrespective of the investment period. Earlier, investments in debt MFs qualified for LTCG taxation after three years.

LTCG taxation is more tax-efficient for investors as it comes with the benefits of indexation.

While scrapping the LTCG tax benefit for debt funds through a finance Bill amendment on March 24, the government allowed investments made up to March 31 to be grandfathered for the next three years to avail of long-term capital gains.

The gush in inflows is expected to have given a boost to the assets under management (AUM) of debt funds that have seen consistent outflows in 18 months. Official figures for March — which is typically a month of outflows of debt schemes due to advance tax payments — will be released in April.

In February, investors withdrew a net of Rs 13,800 crore from debt funds. As a consequence of persistent outflow, the AUM of debt schemes is down over 10 per cent in the past year to Rs 13 trillion. Experts attribute the outflows to an adverse rate-hike cycle and the absence of liquidity with corporates.

With a loss in tax efficiency, the inflow of money into debt schemes is expected to remain fraught. Brokerages have estimated the debt AUM of MF schemes to shrink further this financial year (2023-24) as investors divert money to other fixed-income investment products like bank fixed deposits.