Advisors are recommending their clients to consider arbitrage funds and Monthly Income Plans (MIPs).
The finance minister in his budget speech announced that the long term capital gains tax in debt funds would go up to 20% from 10% currently. This effectively ends the arbitrage opportunity which debt funds so far enjoyed. Besides hiking the long term capital gains tax, the finance minister also raised the definition of long term for debt funds from 12 months to 36 months. This would mean debt fund investors will have to make do with lesser returns if they were to exit before three years. We asked experts on what would be their advice to investors.
First and foremost, advisors are suggesting that investors should hold on to their debt fund investments. “Irrespective of the tax change, investors should hold on to their investments in debt funds as there is a possibility of capital appreciation once interest rates fall. Income funds are already generating good returns,” says Vidya Bala, Head – Mutual Funds, Fundsindia.
For those with a one to two year time horizon and looking for an alternative to avoid paying higher tax in debt funds, arbitrage funds can be ideal. “Arbitrage funds carry low risk and are treated as equity funds. However arbitrage funds may not work if markets are unidirectional,” adds Vidya. Value Research data shows that arbitrage funds have delivered 9% absolute return over a one year period. However, advisors say that arbitrage funds can only give returns as long as arbitrage opportunities are present.
For those having a two to three year horizon, Monthly Income Plans (MIPs) can be a better alternative. MIP offers the best of both worlds – debt and equity. While MIPs also are debt funds, they have the potential to generate higher returns because of the equity component.
“If a client has one year time horizon, then short term or ultra-short term debt funds would be ideal. Long term debt funds as a category will be hit if there is uncertainty on the rate of inflation. For clients with a three year time horizon we would recommend MIPs,” says Nikhil Kothari of Etica Wealth Management. MIPs have delivered 13% absolute return over a one year period, shows Value Research data.
Another category which some advisors are recommending is balanced funds. “Those who have five year horizon can consider balanced funds. However, balanced funds come with some degree of risk,” says Nikhil Kothari.
Balanced funds have delivered 35% return over a one year period, shows Value Research data. While the returns on balanced funds may not be on par as those offered by pure equity funds during market rally, balanced funds bring a certain stability in an investor’s portfolio. This is because balanced funds invest a portion of money in debt instruments.
Vishal Dhawan of Plan Ahead Wealth Advisors however cautions that balanced funds come with a higher degree of risk. “For short term investors we would recommend accrual funds and bank deposits. Duration and accrual based funds can still offer better returns. Open-end structures are better as opposed to closed end funds like FMPs. In open end funds, investors at least can extend their holding period,” says Vishal.
Vidya says that balanced funds can also be considered for five year horizon but investors should be ready to bear the risks associated with markets. “One bad market can shave off a substantial part of returns of balanced funds.”
Vidya advises accrual funds for investors with a three to five year horizon.
What are you recommending your clients?
