Mutual fund myopia

From April 1, 2023, the taxation structure of some mutual fund categories changed. If you are reading my column, you are likely to be among those who know about these changes and understand them. For most people, the actual change in the amount of tax paid will not be significant. For some, especially those who come in the lower income tax slabs, there could be a reduction in tax. My biggest criticism is that some aspects of this change - like the removal of cost inflation indexation - are unfair and unprincipled. However, they are not going to impoverish anyone. Slab-based taxation is itself fair and progressive - it ensures that those with higher incomes pay more tax. Ideally, we should have an indexation of gains, which are then added to income.

However, enough on the taxation. Now that the dust has settled, my main reaction to the entire episode is that I'm aghast at the rank opportunism which mutual fund sellers displayed in using the tax changes to create a 'buying panic'. By and large, they succeeded. In the debt fund categories, Rs 39,325 crore flowed in the five days from March 27 to March 31, 2023. In the preceding part of the month, this inflow was just Rs 4,430 crore. These numbers are estimates deduced by us at Value Research based on the daily AUM figures and the daily NAVs released by the mutual funds.

The truth is that if you weren't already planning to invest in these funds, there was no substantial benefit to doing it at that point. Essentially, salespeople pushed investors to choose specific funds based on future tax increases without considering whether the funds were suitable for those investors. It risked the investors' financial planning and prioritised the short-term advantage of the sellers. Notably, it also risks the sellers' own long-term interests, but I don't think anyone cares about it any more.

This fits a pattern, actually. Just weeks earlier, SEBI sent a letter to the Association of Mutual Funds of India (AMFI) asking the fund houses not to charge an additional expense ratio for providing an incentive to the distributors who sell mutual fund schemes in the so-called B30 cities. SEBI categorises cities into two groups, Top 30 (T30) and Beyond 30 (B30). In the past, SEBI permitted fund houses to charge a 0.30 per cent extra expense ratio on new investments of up to Rs 2 lakh from B30 cities. The intent was to incentivise distributors to promote mutual funds in smaller cities.

However, this extra money was being widely misused, leading to the splitting of investments and churning of portfolios. Distributors split investments to take advantage of the incentive, which was only applicable on investments up to Rs 2 lakh and only the first year, resulting in unnecessary churning. As a result, SEBI has had to suspend the extra charge. Clearly, everyone in the mutual fund industry knew about this but went along, again prioritising the short-term over the long-term.

Many of the other regulatory changes in the last two decades, from the mandatory timestamping to the creation of direct funds to the abolition of entry loads and many more, have all been part of the same story. Each of these wrenching regulatory changes has been driven by the need to respond to the rampant exploitation of the smallest window of opportunity to create short-term advantages.

Consistently, the Indian fund industry behaves in a manner focused on the short-term. Instead of looking at the enormous potential for expanding the investor base, it has been more interested in squeezing more out of the existing customer base. Digitisation of the entire process from investing to KYC to tracking and then redemptions can be a great lubricant for expanding the reach of mutual funds much faster if only that catches the interest of Indian mutual funds.

Suggested read:
Why are mutual funds creating panic?
SEBI suspends additional incentive for selling mutual funds in B30 cities