 "money, funds")
With the change in taxation taking the sheen off debt funds, asset management companies (AMCs) are looking for ways to prevent flows from getting diverted to other fixed-income products like bank fixed deposits (FDs).
They have a handful of options at their disposal — managing funds more actively, raising credit and duration risks, bringing in cost-efficiencies to lower expenses, and launching debt-oriented funds with 35 per cent arbitrage or equity component or a mix of both.
At least one medium-sized fund house is in the process of coming out with a debt-plus arbitrage fund.
Arbitrage is a low-risk equity strategy that generates returns comparable with shorter-duration debt schemes.
Since the long-term capital gains (LTCG) taxation benefits have been withdrawn only for schemes with less than 35 per cent allocation in equity, any fund with 35 per cent or more in equity still qualifies for the 20 per cent taxation with indexation benefits.
However, this option (debt-plus arbitrage) is open only to select AMCs because such a product is only possible as a multi-asset or balanced advantage fund and most larger fund houses have the two products.
“Debt funds with 35 per cent arbitrage is a possibility. Since arbitrage is not a high-yielding strategy, we are not sure if investors will show interest,” said a fund manager of another fund house.
Active management of debt funds is one option most AMCs are looking at. Managing funds more actively will require fund managers to make timely shifts in the duration of the portfolio, consistent with market conditions, and identify safe but lower-rated papers to improve returns.
“It’s time to bring back active management in its truest sense. It had taken a back seat after the Infrastructure Leasing & Financial Services and Franklin Templeton fiasco. Fund managers need to step up and display their talent by identifying the right credit and delivering alpha,” said the chief executive officer of a large fund house.
Increasing investments in high-yield real estate investment trusts and infrastructure investment trusts is another option on the table.
Sandeep Bagla, CEO of TRUST Mutual Fund, said the change in taxation could change how investors look at debt funds.
"The whole ecosystem could shift from an FD-type investing to a market risk-oriented one. For that, the industry needs to educate investors to look beyond yields and aim for capital gains possibilities," he said, adding there is scope for newer debt products that take risks in a calibrated manner.
The fund manager quoted earlier said that the change in taxation will free up fund managers to make timely shifts in duration.
“Earlier, fund managers would take unitholders’ investment duration into account because most investors would withdraw shortly after completing three years to book profits and avail of the LTCG benefits. Hence, the fund manager had to be mindful of the impending liquidity requirements and the risks in the portfolio,” the fund manager said.
Debt funds, already struggling to gather inflows in the last year and a half, were expecting a turnaround in fortunes with the rate-cut cycle almost nearing its end and yields staying elevated. But a loss in tax advantage may prove to be a dampener.
In the year ended February 2023, active debt schemes collectively saw their assets under management decline 10 per cent to Rs 13 trillion. This trend is set to see a reversal in March as investors poured Rs 40,000 crore into popular medium- to longer-duration debt funds in the last week of March to lock in the elevated yields before a change in taxation kicked in on April 1, 2023.
Arun Kumar, head-research, FundsIndia, believes investors may continue to plough money into debt schemes after the tax change since the current interest-rate scenario works in their favour.
“Debt funds have an advantage over bank FDs during a rate-cut cycle as there’s scope for capital appreciation,” he said.
The rate-hike cycle in India is almost at its peak and the Reserve Bank of India is expected to start cutting rates later this fiscal year (2023-24).
