Arbitrage schemes of mutual funds back in focus as debt plans face higher tax

MUMBAI: Arbitrage schemes of mutual funds are set to make a comeback in the wake of the government's proposal in the Union Budget to raise taxes on debt schemes.

Mutual fund houses are planning to push this product, which aims to benefit from price anomalies between shares and futures contracts, to attract a portion of the likely outflows from fixed maturity plans (FMPs) -- a close ended debt scheme that is expected to be most impacted by the new tax plan, according to industry officials.

Arbitrage schemes, which have been fetching returns similar to a fixed income instruments, fall under the equity category for taxation. So, if an investor holds an equity scheme for more than a year, he does not have to pay capital gains tax. Below one year, equity schemes attract 15% capital gains tax.

"There are very few mutual fund products left like arbitrage schemes that are tax efficient and relatively safe too," said Sunil Jhaveri, chairman, MSJ Capital & Corporate Services, a mutual fund advisor. "Some money from FMPs can flow into arbitrage schemes."

These schemes had fallen out of investors' favour since 2009 because debt products have been fetching better returns. In the last one year, returns have improved but debt products still remained popular. Average returns of schemes in this category were 9.35% in the last one year, according to Value Research, a mutual fund tracker. In the same period, FMPs have fetched 8.5%-10%, be fore accounting for taxes.

The government, in the budget, has proposed to increase long-term capital gains tax for all schemes, other than equity-oriented schemes, to 20% from 10%. Also, the period defined as long term has been increased from 12 months to 36 months. The steps align taxes of mutual fund debt schemes to that of bank fixed deposits.

These moves, which would eat into returns of debt schemes, are expected to take the sheen off FMPs, which

have turbocharged assets of the mutual fund industry in the last three years in the absence of flows into equity schemes. According to unofficial estimates, assets under management under FMPs would be around Rs 1.75 lakh crore. The industry's AUM is roughly Rs 9.87 lakh crore.

"There would be some sharp outflows from FMPs, especially those above one-year tenure (such as 366day FMPs) because a lot of money had come into these schemes keeping in mind the tax advantage over bank FDs," said Akshay Gupta, ygroup executive head -asset management, private equity and private wealth at Indiabulls.

But, arbitrage schemes will not be in a position to absorb the large outflows from FMPs beyond a point, said mutual fund industry officials. This is because arbitrage opportunities have been on the wane though they have picked up in recent months thanks to the euphoria in the market. "Arbitrage schemes cannot absorb so much of FMP money . Still, a large chunk will flow into bank FDs," said a senior mutual fund industry official.

Economics Times
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Rajesh Kumar Kathpalia ¤ SMC Global
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