Prepare your investors in ultra-short and short term debt funds for higher volatility. Read on to find why?
Mumbai: The new valuation norm by SEBI which came into effect on August 1, 2010 mandates mutual funds to value financial securities of greater than 91 days at market prices. Valuing investments at most current market prices is called marking to market. Earlier, these untraded securities were valued on amortization basis. Liquid schemes will be more volatile as they are now subject to changes in interest rates and liquidity in the market.
The new norm helps to make debt valuation transparent and enables better comparison across funds. To smoothen out the returns, funds may be expected to invest in securities less than 91 days.
Short-term funds are primarily used by corporates to park cash that is unused for short periods of times, often no more than a week or so. These funds suit the purpose well because of their highly predictable returns. However, under the new valuation norms, these funds are going to be a lot less predictable.
Lower taxes have also encouraged investors to stick to liquid plus schemes compared to liquid funds or bank fixed deposits. Interest income on fixed deposits is taxed at 33%, but the dividend distribution tax on dividends of liquid plus funds is at 22.7% for corporate and 14% for individuals. Similarly, dividend distribution tax on liquid funds is 28.3%. The burden of dividend distribution tax is on the payer of the dividend and not the recipient. It’s for this reason that many institutional investors prefer liquid plus over liquid schemes and fixed deposits.
