Your Fund Portfolio

I want to invest ₹5 lakh in mutual funds for one year. I am looking for 9-10 per cent return on the investment.

Manik Rauthan

We are afraid there are no mutual funds we can recommend that can fetch you 9-10 per cent within one year.

A minimum three-year holding period is essential to buy into equity or balanced mutual funds. The stock markets and large-cap equity funds have already made a 14 per cent annual return in the last three years and are hovering at a new lifetime high. From current valuation levels, it is difficult to say if stocks will correct lower or head higher in the next one year. Investments in equity funds made at this point in time, therefore, risk a capital loss. This calls for a longer holding period. A holding period of four-five years will give your investments enough time to recover if the markets do correct.

In the case of debt funds too, returns can be subject to fluctuations based on interest rate movements in the economy. Long-term debt fund categories such as Gilt Funds and Income Funds are, again, sitting on a 10-12 per cent return for the last three years. This has come about because interest rates in the economy have fallen sharply in this period, from above 9 per cent to 6.5 per cent. (When rates fall, bond fund NAVs rise).

But going forward, a similar fall in interest rates is unlikely. Returns from debt funds will, therefore, moderate. The prevailing yields in the market are closer to 6.5-7 per cent for one year. If rates bottom out and actually rise sharply, you can even witness a capital loss on your long-term debt funds for short periods. The safe option, therefore, is to invest in liquid funds which are targeted at short-term investors and can deliver 6.5-7 per cent returns. Do note that these are not tax-free. Dividends declared by these funds are subject to a 28 per cent tax which is deducted before paying out dividends. If you opt for the growth option, the short-term capital gains you make will be subject to tax at your slab rate.

For a more tax-efficient return, consider an arbitrage fund which can earn returns similar to liquid funds. As these funds are equity-oriented, the returns are tax-free in your hands. If willing to take some risk of capital losses, consider hybrid funds such as HDFC Equity Savings Fund or ICICI Pru Balanced Advantage Fund, which have a limited 20-30 per cent equity exposure.

I feel AMCs are trying to force investors to go through advisors. I have investments in ICICI Pru Balanced Fund-Regular and Direct. Every month, the AMC is declaring a higher dividend for the Regular plan than the Direct plan. Why?

Satya Paul Gupta

You have not understood this correctly. The lower dividend on the Direct plan is not a ploy by the AMC to force investors to go through advisors. In fact, there have been quite a few instances of schemes declaring lower dividend on their Direct plans as compared to Regular plans.

The Direct plans are forced to declare lower dividends because of SEBI rules that require schemes to pay dividends only out of their ‘distributable surplus’ or realised stock market gains. This is calculated as per a SEBI formula. A scheme’s distributable surplus is its NAV minus its face value/unrealised gains and accumulated unit premium reserves.

Now, Direct plans in many schemes may have a lower ‘distributable surplus’ because they have come into being more recently (Direct options were flagged off only in 2013), while Regular plans have been around much longer. However, the lower dividend from a Direct plan need not worry you or force you to switch to a Regular option. As an investor, what matters to you is the fund’s total return — including both NAV gains and dividends received. If Direct plans declare lower dividends, the remaining ‘profit’ will be retained in the NAV and will come to you when you sell the units. In the long run, Direct plans will outperform Regular plans due to lower costs. If you compare the NAV of your Direct plan with the Regular plan today, you will find that it is already higher.

Send your queries to mf@thehindu.co.in

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