Misusing STPs

If agents are using systematic transfer plans to trick investors, they should be cracked down upon…

I recently came across two cases of two investment advisors giving some decidedly weird advice that could have had no purpose except to increase the advisors’ own commissions while harming the investors’ interests. Both involve conduct which is technically legal but which the fund companies should crack down upon.

The cases involve an investment facility known as the Systematic Transfer Plan (STP). STP is a kind of SIP wherein the money, instead of being a fresh investment, comes from an investment in another fund. The point of an SIP is that it is not safe to invest a lump-sum into equity funds at one go. If you come upon a sum of money that you’d like to invest in equity, it is better to invest it all in a low-risk debt fund (a liquid fund) and then give instructions for a part of it to be automatically redeemed from the liquid fund and invested into the equity fund of your choice every month.

Here’s an example. Let’s say that you’d like to invest Rs 2 lakh into an equity fund. If you put it in all at one go, it’s possible that the markets might fall and then you would make a loss. To average out your buying price, you would put it all in a liquid fund and give instructions for say, Rs 25,000 to be shifted to the chosen equity fund for each of the next eight months.

In the first case, the advisor made the investor invest the entire amount into an equity fund and then started an STP from that into another equity fund! From any sane perspective, this is a meaningless activity, except that it doubles the advisor’s commission. The investor is exposed to the risk of investing a lump-sum in an equity fund. Then his money is transferred to another equity fund and the agent takes a commission on both transactions. If the investor makes anything on the first fund then he pays short-term capital gains tax since the investment is held for less than a year.

The second case was even worse. Here, I happened to be personally involved as the investor is known to me and works with a major media organisation. He asked me for advice on investing a sum of money and I asked him to put it all into HDFC Liquid Fund and then do an STP into a HDFC Prudence, an equity-heavy balanced fund. The fund distributor in this case was HDFC Bank where my friend also had his bank account. Many months later, when he discussed his investments with me, I realised that the bank had done the opposite. They had invested his money in a lump-sum in HDFC Prudence and then done an STP into the liquid fund!

This makes no sense at all. The whole point of an STP is to shield the investor from the risk of a sudden equity investment and then, in the long-term, get him all the benefits of the superior returns of an extended investment in equity. Instead, he got all the risk of a sudden equity investment, then paid short-term capital gains tax on whatever returns he made and then his money was put in a low-return liquid fund for the long-term. Instead of optimising his returns, here was a strategy carefully designed to pessimise his returns, if I may invent a word.

I’m not sure whether these are common tricks that agents play on investors, but on the general principle of there never being just one cockroach in a kitchen, it’s something that investors should be aware of. No matter what, you must make an effort to understand what agents selling financial services are actually doing.

There’s one more issue. These types of actions should not be allowed at all by the fund companies and if there are any agents who have done it regularly, then they should be cracked down upon.

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