NOT MUCH TO CELEBRATE FOR MUTUAL FUNDS IN THE BUDGET
There are different ways in which the mutual funds could have gained from the Union Budget. Normally, the most popular thing the government does is to put more money into the hands of people, which gets channelled into mutual funds. The other ways is to offer tax sops by making dividends or capital gains on mutual funds more attractive.
Also, there are certain exemptions that were offered to mutual funds for reinvestment of capital gains, which have since been withdrawn. Mutual funds also tend to benefit from greater parity with other similar products like ULIPs. Unfortunately, the budget did not have any such benefit for mutual funds. In fact, the AMFI has been giving its wish list to the Finance Minister each year, but not much has moved on that front.
SOME MF EXPECTATIONS THAT DID NOT MATERIALIZE
The mutual funds had some strong expectations ahead of the Union Budget. Mutual funds have played a stellar role in channelling savings and standing up as an alternative to FPIs. However, most of the expectations did not materialize.
- There were expectations that the special exemption of ₹1.25 lakhs for equities and equity mutual funds would be raised to ₹2.00 lakhs. That did not happen.
- There were also expectations that the capital gains on equity and equity funds above 5 years, would be made tax-free. Nothing of that kind happened in the Budget.
- There were demands to offer debt funds parity in tax treatment with debentures and other mutual funds to enable better asset allocation. That also did not happen.
- There was one more expectation that the budget will give debt funds parity in tax treatment with equity funds and ELSS parity with ULIPs. That also did not happen.
However, there were some other changes that will impact mutual funds in India.
STT HIKE WILL IMPACT THE MUTUAL FUNDS
One can argue that the equities and equity mutual fund have been spared any hike in STT. The hike in STT has been effective only for futures and options. But that would still impact the mutual funds. Here is why.
- Most mutual funds use derivatives for hedging risk or even to take opportunistic positions in equity when the futures are at a discount. Now that gets more expensive.
- Mutual funds actively use derivatives in arbitrage funds. These arbitrage funds are cash futures funds that compete with liquid funds. However, with a higher STT, their returns could get impacted and it remains to be seen how the compete with liquid funds.
- Thirdly, there are also certain hybrid categories that make extensive use of derivatives as a proxy for equities. Equity Savings Fund and Multi Asset Allocation Funds depend heavily on Futures and Options to ensure risk management and equity exposure.
- Above all, the higher cost of futures and options due to higher STT will result in higher total expense ratios (TER) for the funds and such costs will have to be passed on to the investors, resulting in lower effective returns.
The other impact (positive) could come from taxation of sovereign gold bonds.
CHANGE IN SGB TAXATION COULD BENEFIT MUTUAL FUNDS
Hidden in the fine print of the Union Budget was the details about the proposed change in taxation of sovereign gold bonds (SGB) effective from April 01, 2026. Currently, any SGB, whether purchased directly from the RBI counter as part of the initial issue, or purchased from the secondary market is exempt from capital gains on redemption if it is held up to the maturity date after 8 years. Now, this budget has changed that clause.
Going ahead, from April 01, 2026, the capital gains tax exemption will only be available to investors who purchased the SGBs directly from the RBI as part of the initial issue. For those who bought the SGBs in the secondary markets, the gains will be treated as short term capital gains or as long term capital gains, as the case may be. This is likely to reduce the attractiveness of holding SGBs till maturity if you bought in the secondary market.
What are the implications. Firstly, this would mean that the government will only grant tax exemption on SGBs bought from the RBI window. For the others, the facility is not available, so they may as well make the best of premature redemptions done by the RBI from time to time. When such funds are taken out of SGBs after liquidation in premature redemption, such investors are likely to opt for gold funds or gold ETFs. Thus, the mutual funds would be a big beneficiary of this change in tax rules on SGBs. They could get more flows.
There is really not much for mutual funds to savour in the Union Budget. Most of the things they hoped for did not materialize. While the SGB shift could be a marginal benefit, the higher STT is going to pose a problem for mutual funds. Overall, mutual funds would not really be overwhelmed by the budget.
| Summary
Mutual funds had a long list of demands ahead of the budget announcement, but most of these demands were not heeded to. One had hoped that at least the parity to debt funds would merit some attention, but even that was not to be. What cannot be gainsaid is that the STT imposition will surely have an impact on the performance of mutual funds, especially the arbitrage funds and the equity savings funds. Of course, one can take respite from the small gains from the change in SGB taxation. |