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Three debt mutual funds are about to undergo a transformation.
- Starting January 28, 2025, Bandhan All Seasons Bond Fund will become Bandhan Income Plus Arbitrage Fund of Funds.
- Axis All Seasons Debt Fund of Funds will become Axis Income Advantage Fund of Funds on February 14, 2025.
- Effective March 3, 2025, Aditya Birla Sun Life Active Debt Multi Manager FoF will become Aditya Birla Sun Life Debt Plus Arbitrage FoF.
To put it simply, these funds will incorporate arbitrage strategies into their portfolios while remaining fund of funds (FoFs). For those unaware, arbitrage is a strategy that profits from price differences by simultaneously buying low in one market and selling high in another.
How will these two funds' tax reduce?
Debt funds have been long favoured for stability, but recent tax changes have made them less attractive. From April 1, 2023, capital gains on debt mutual funds are taxed as per the income tax slab rate of the investor , regardless of any holding period.
However, by using arbitrage strategies, these two funds will allow investors to enjoy tax-efficient returns. Put simply, the tax on gains will be much lower.
Here's how:
How the funds are changing and what it means for tax
| Fund | Current structure | Revised structure | Effective date | Current taxation | Taxation under revised structure |
|---|---|---|---|---|---|
| Bandhan All Seasons Bond Fund | FoF investing in debt instruments | FoF investing in arbitrage and debt | January 28, 2025 | Gains taxed as per slab rate (10, 20, or 30 per cent) |
•12.5 per cent if sold after two years •Slab rate if sold within two years |
| Axis All Seasons Debt FoF | FoF investing in debt instruments | FoF investing up to 45 per cent in arbitrage and the remaining in debt | February 14, 2025 | Gains taxed as per slab rate (10, 20, or 30 per cent) |
•12.5 per cent if sold after two years •Slab rate if sold within two years |
| Aditya Birla Sun life Active Debt Multi Manager FoF | FoF investing in debt instruments | FoF investing up to 45 per cent in arbitrage and the remaining in debt | March 3, 2025 | Gains taxed as per slab rate (10, 20, or 30 per cent) |
•12.5 per cent if sold after two years •Slab rate if sold within two years |
Gains from these revamped funds, if held for over two years, will be taxed at a 12.5 per cent rate, compared to the current slab rates of up to 30 per cent.
For example, suppose you earn a gain of Rs 50,000 from the Bandhan fund and are in the 30 per cent tax bracket. Before the restructuring, the tax liability would have been Rs 15,000 (30 per cent of Rs 50,000). However, it will now drop to Rs 6,250 (12.5 per cent of Rs 50,000), saving you almost 60 per cent on tax.
This makes the revised structure particularly appealing to investors in higher tax brackets, ensuring more of the returns stay in their pocket.
What about returns and stability?
It's natural to wonder if introducing arbitrage strategies will compromise the stability that debt fund investors enjoy. However, while arbitrage strategies may not be entirely immune to market fluctuations, it is unlikely to be significant enough to worry about.
That said, do note that returns from arbitrage funds may slightly lag traditional debt funds. For instance, over a two-year period, arbitrage funds have averaged 5.5 per cent annualised returns, compared to 6.55 per cent for short-duration debt funds.
Returns comparison: Arbitrage vs Debt funds
| Type of fund | Average annualised return (Two years) | Worst 6-month return |
|---|---|---|
| Arbitrage funds | 5.50 per cent | 0.92 per cent |
| Short-duration debt funds | 6.55 per cent | 0.09 per cent |
| Category average of direct plans rolled on a daily basis over the last five years, as of January 15, 2025 | ||
The bottom line
These transformations are part of a broader trend in the fund industry, where fund houses are continuously tweaking fund structures to enhance tax efficiency while maintaining stability. For instance, Kotak All Weather Debt FoF became Kotak Income Plus Arbitrage FoF last year, tweaking its fundamental attributes along similar lines.
Additionally, equity savings funds from ICICI Prudential , Franklin , and PGIM India have significantly reduced their pure equity exposure to very low levels (around 15-20 per cent) while maintaining total equity allocation above 65 per cent to retain equity-like tax benefits.
Similarly, the revamped Bandhan, Axis and Aditya Birla funds aim to give debt fund investors better tax efficiency while maintaining stability. That said, it's crucial to observe how this combination of arbitrage and debt plays out in the long term in terms of performance and expense ratios.
Also read: Why one Nasdaq FOF has earned 60 per cent more?
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