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The day the FM presented the Budget with its unexpected changes on debt fund taxation, most of us at DFDA were shell-shocked. Immediate reactions that day ranged from "Ab ki bar, tax sarkar", to "Acche din gaye" - reflecting the immediate disappointment amongst our members from a Government we had so many expectations from.
However, after some introspection and calm analysis, we at DFDA concluded that these tax changes essentially involve taking short term pain for long term gain. It's a bitter pill no doubt, but one which we at DFDA strongly believe, will help rid the MF industry of a disease that it has not wanted to treat for so long. What will emerge from this bitter pill, is a stronger industry which is more sharply focused on where its priorities ought to be.
We shared this perspective with some of our friends in the industry, who not only understood what we were trying to say, but also were deeply appreciative of the fact that we are among the minority actually thinking about the long term, as opposed to so many who are crying about the change and asking for a roll back. This feedback from some industry friends has motivated us to share our perspectives with the entire industry, through Wealth Forum. I am writing this piece with the hope that we can all get aligned on where our priorities ought to be, rather than hoping to continue with our old ways, which have not helped us build this industry on solid foundations.
Before proceeding, a personal disclaimer is in order. My firm, Vista Wealth, is impacted significantly by this change. Last year, at the Wealth Forum annual conference, we were recognized with the Think BIG award for highest growth nationally in the retail debt segment. We have a sizeable business in debt funds, and my business is as impacted as everyone else's, if not more. Yet, I firmly believe that for all of us, this is short term pain for long term gain.
Before we start the positives lets understand its impact which is not as hard as initially believed.
Impact analysis
FMPs : This is clearly at the centre of the entire storm and the fund industry expects maximum damage to this product. Estimates of potential loss of AuM in FMPs range from Rs. 50,000 crs to Rs. 150,000 crs. A lot of heartburn is being caused in the industry due to this AuM loss.
My question to all in the industry is this : are FMPs our friends or our enemies? Should we be terrified by shrinkage of FMPs or happy about it? This is a 5 paisa commodity business that doesn't add much value to anybody, yet takes up huge amount of everybody's time and energy. Distributors get 5 paisa, fund houses get 5 paisa and large investors were getting a tax arbitrage and reducing their tax on treasury income.
For distributors, when you contrast the client engagement and sales process relating to accrual funds as part of a solution for financial goals as opposed to selling FMPs on the basis of today's indicative yields, you can see which one enhances your client engagement and helps build longer lasting relationships.
Every single day, there is an FMP that is opening or closing. Almost all conversations between AMC sales people and distributors is around an FMP that is either opening or closing today, for which money needs to be mobilized and targets completed. Think of how much of AMC and distributor time has been spent on this 5 paisa business that adds value to nobody. Think of how much more productive we can all become, and focus on genuine business building, now that this craze of FMP closing dates is no longer top of mind in the industry.
Yes, FMPs will shrink considerably. But, as I said, it is for us to honestly introspect and ask ourselves : should we be moaning and groaning, or should we be relieved?
Short Term Funds : This is not a very large category and most money here was anyway for less than 1 year, so I don't see too much of an impact on flows into this segment as a result of the tax changes.
Accrual Funds : For retail distributors, this has become a bread and butter product, and will continue to remain so, despite the tax changes. Schemes in this category have exit loads ranging from 1 year to 2.5 years. AUM of many schemes with exit loads of anyway 2 - 2.5 years has increased considerably in last few years which clearly shows that clients' time horizons were anyway 2 years plus. I don't think it will be too much of a stretch for clients who have 2-2.5 year money, to increase their horizon to 3 years, in order to avail the tax benefits. This will require some conversations by us with all our clients, but I don't think there is much cause for concern on extending the time horizon to 3 years.
In fact, longer time horizons give fund managers more opportunities to deliver alpha, which is the core of their job.
Liquid Funds : Convenience was the key anyway for liquid funds followed by holding period of as less as 1-2 days. Tax came in only next. The first two aspects remain, the third has got marginally worse. I don't see a huge shift from liquid funds to 7 day bank deposits, as a consequence of tax changes.
Income Funds : Duration funds were always sold as tactical plays, and money will come in when it is perceived that duration strategy will yield good short to medium term results. This will happen regardless of tax. So here again, I don't see too much cause for concern.
DFDA wants only 1 change in the tax treatment for non-equity funds
As you can see, the product that is going to be most impacted is really FMPs, which in our view is not worth fretting too much about. That said, one has to grant that tax benefits are an additional attraction for retail investors and if we want retail debt to achieve deeper penetration, continuation of benefits for RETAIL investors would have been a good thing. When DFDA made its representation to the Finance Ministry, we made only 1 point. We acknowledged that the tax arbitrage is being used a lot more by corporate and HNI investors, as their investments are much larger. We acknowledged that extending this tax benefit for large investors does not support the cause of retail penetration. We only asked for retention of these tax benefits for RETAIL investors and suggested a cap of Rs.25 lakhs per PAN as the threshold upto which these tax benefits will be permitted. Any PAN with more than this level of investments should be allowed tax benefit limited to Rs. 25 lakhs. Corporate and institutional investors must not be allowed this tax benefit. If the Ministry sees merit in this proposal, we will be able to address the issue that the ministry is upset about - which is misuse of tax arbitrage by big investors - while retaining the benefit for smaller investors in order to promote deeper retail penetration. We at DFDA would like everyone in the industry to support this move, which we think will be a good solution from all points of view.
In this context, I must say that when I read FIFA's representation to the FM on Wealth Forum, I was a little disappointed. The very first recommendation made by FIFA was restoration of the 10% tax rate. In my experience, and having consulted many others too, I have rarely seen the 10% tax rate being actually utilized by investors - they always prefer using the 20% with indexation option. Why ask for the 10% rate, when it is not relevant? FIFA has many luminaries of the IFA fraternity and is well respected because of its pedigree. I would urge FIFA, especially since it seeks to represent IFAs pan India when making suggestions to regulators and to the Government, to adopt a more consultative approach and take in views from more stakeholders before making a final representation on behalf of all of us.
Why are we saying long term gain?
We know there is short term pain. So, where is the long term gain? What beneficial impact can this bitter pill give us in the long run? The benefit will come from a fundamental shift in the way mutual funds are perceived by every stakeholder. Here is how we at DFDA see attitudes of five key stakeholders changing, consequent to this change in tax laws. The five stakeholders are retail investors, corporate investors, AMCs, distributors and regulators/Government.
Retail investors
For far too long, we have been giving confusing messages to the investor. On the one hand, we talk about long term planning and long term wealth creation. But on the other hand, the products that we distribute become long term after a 1 year holding. And, we spend a lot of time in products that are even shorter in terms of ideal holding period. 1 year has become the de-facto definition for long term for our industry's products. Now, we hope that the same logic that made 1 year as the definition of long term, will shift the time period to 3 years. It may still not be ideal, but engaging in conversations with clients for a holding period of 3 years and above is certainly healthier for clients and the industry than targeting 1 year as the horizon. We think this will promote long term investing perhaps much more than any amount of investor education advertisements encouraging long term investing. We see this as a good stepping stone to getting investors more aligned to accepting mutual funds as long term wealth creation and protection solutions rather than short term money making alternatives.
AMCs
We have attended numerous conferences where AMC seniors make presentations on the need for retail penetration, the untapped retail opportunity etc etc. And yet, the ground reality outside these conferences is that AMCs continue to chase big ticket money as their number 1 priority. With corporate interest in mutual funds now set to reduce, AMC managements will have no alternative but to focus whole-heartedly on expanding their retail businesses, which will enable the industry to stand on a much firmer footing.
There is a book, "The Secret", which has wonderful lessons for all of us, and which is one of my favourites. One of the key messages from this book is that energy goes where your attention is. As long as your attention is on getting those few big cheques, your energies will be diverted only to that cause, and not to the cause of getting 1000 retail cheques that add up to 1 corporate cheque, but which stay invested for the long term, unlike the corporate cheque that goes away after 3 months.
Now that attention towards corporate segment will reduce, energies will finally go into building the retail business. This augurs well for the industry and for retail investors.
Corporate investors
A friend of mine did an analysis recently where he concluded that in the old tax regime for debt funds, it actually made more sense for large companies to stay invested in debt funds rather than spend it on business expansion. A 10% effective post tax return meant an equivalent pre-tax return of 15%. For the incremental project risks to be taken for any business expansion, company shareholders would expect much higher than 15% pre-tax ROCE from new projects - else a 10% post tax from debt funds would be a better alternative.
Now, the equation will change. The alternative of keeping money idle is less attractive, because the tax arbitrage is no longer available. One hopes that a positive economic environment coupled with less attractive alternative use of idle funds will nudge companies to invest once again in their businesses. As we all know, once the corporate capex cycle starts, it gives a big boost to GDP growth, to employment, to money circulation - and all of us will stand to benefit from this higher level of economic activity.
Regulator / Government
Lets pause and think for a moment about how the regulator and the Government would be thinking of the mutual fund industry. Every fund house, every CA, every corporate investor, most HNIs - all of them have been very sharply focused on extracting every bit of tax benefit that can be extracted from mutual funds. Whether it is the tax arbitrage on FMPs or bonus stripping or dividend stripping as long as that loophole existed - there is a huge focus on how to abuse the mutual fund product to help high tax payers save tax. The Government and the regulator want mutual funds to do the job of efficient allocation of household savings into capital forming assets - equity and debt. The intention was never for mutual funds to become a tax haven for high tax payers. But, with our industry's sharp focus on creating tax shelters for high income earners, no wonder that we have got onto the bad books of the powers that be. If the FM makes a statement in Parliament that debt funds provide unnecessary tax arbitrage to high tax payers and that retail investors are not really availing of this benefit in any meaningful way, that is a very strong statement about how the Government sees the industry. The fact is that despite all the representations made by the industry, the only concession given was the correction of an obvious retrospective taxation provision, for redemptions done prior to Budget announcement.
SEBI has been repeatedly asking fund houses to make more efforts towards retail penetration, and has also started asking for branch expansion status from each AMC. Its message is very clear - the regulator is not yet satisfied that the industry is directing all its energies towards retail expansion.
We need to face the reality that the regulator and the Government do not see the fund industry performing its economic role to the extent they believe ought to be done. Now that demand from corporate investors for mutual fund products may reduce, the fund industry has a golden opportunity to deliver on the mandate that the Government has provided it.
Lets look at another perspective. In the Railway Budget, fare hikes of over Rs.8000 crores were announced. There was a hue and cry, but finally everyone understood that this is a bitter pill to be swallowed for Railways to become financially viable and grow on a strong footing. This bitter pill impacts millions of Indian citizens, especially many from relatively weaker sections of society.
I am told that a conservative estimate of the incremental tax that will be paid as a result of changes in debt fund taxes is a mindboggling Rs. 8000 crores. And, most of this 8000 crores will be paid by the top 5000 investors in mutual funds - corporates and super HNIs. Think about it - the fund industry is crying hoarse about incremental tax liability on 5000 big investors, while all of us say that the aam aadmi must pay higher rail fares in national interest. How do you think the Government will react when they see the fund industry trying hard to protect tax shelters that benefit high tax payers?
Many of us voted this Government in and expected them to take tough decisions in national interest. We expect them to cut subsidies on fuel, fertilizers, food etc. We expect them to cut out subsidies for segments of population who don't need these subsidies, so that resources can be diverted towards more productive purposes. But, when a tax subsidy that was largely used by 5000 large investors is withdrawn, we raise a hue and cry and seek restoration of the benefit! This is why we at DFDA support withdrawal of the tax subsidy for big investors while seeking retention of the same for small investors.
The faster we align ourselves with what the true mission of this industry is, the more support we will get from the Government and the regulator.
Distributors
We distributors must focus on what our key role is - to expand distribution of mutual fund products across the country, to reach out to more and more new investors and help them understand how mutual funds can and should become an integral part of their savings and investment options. As the fund industry starts increasing its attention to the retail side of its business, those of us who are sharply focused on retail, will find a lot more engagement and support for our growth initiatives from fund houses. Secondly, now that investor psychology will gradually reorient to 3 years as the new definition of long term, distributors have a golden opportunity to pitch their offerings as long term needs based solutions rather than continuing in a transactional mode, which is what something like FMPs encourages. Distributors who are aligned with the new realities will benefit the most. There's a bitter pill that we have been asked to swallow - but, it is something that can help us get onto the track of strong sustainable growth.
Our message to the industry
My grandmother used to say, "Those who always look for crutches will never be able to stand on their own feet." The crutches have been taken away. Its time for us to show that we can stand on our own feet.
Our message to AMCs is simple : we are eagerly waiting for your whole-hearted support for retail penetration efforts. Please give your whole and undivided attention to retail and see how much energy flows into this business.
Our message to fellow distributors is only one : after all that's happened, if you still find AMCs engaging with you on bonus stripping options and other such tax avoidance mechanisms, please shun those AMCs and work with those who are aligned with the future rather than the past.
Let the regulator, the Government and the investors recognize us for the value we add rather than the sharp practices we encourage.
All the 10 growth drivers are very much intact
In my last article on 3 bull runs (Click Here), I discussed 10 big growth drivers that should help us scale up our businesses several fold in the coming years. All those growth drivers are very much in place, with our without tax changes for debt funds. Lets keep that big picture in mind and focus on growing our businesses by serving more and more individual customers.
I closed that article with the one big risk which is direct plans. At DFDA, we think there is now perhaps a solution for us to deal with this risk factor. NSE we understand has taken a stake in CAMS and is developing an MF platform meant only for distributors, unlike MF Utility which will also be available to direct investors. We think distributors will do well to support the NSE platform rather than MF Utility. We need to be united in this effort and encourage a platform that helps us serve investors better rather than one that encourages investors to bypass us.
To summarize, with one stroke of legislation, the industry now finds itself in a situation where it has to move purposefully in the direction it ought to, and deliver on the broader mission which underpins its existence - which is to serve millions of retail investors and help them realize their financial aspirations. Lets move ahead on this path without losing focus any longer.
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Large sections of the fund industry and the distribution fraternity are worried about the negative fallout of tax changes for debt funds in terms of reduced AuM and unpleasant investor experiences due to their tax planning getting upset. Ashish and Manish Goel of Vista Wealth and their fellow DFDA members however have a strikingly different view on this change. They firmly believe this is a bitter pill that must be swallowed to enable the industry to grow on strong and sustainable foundations. Ashish asks some fundamental questions on why the industry is crying itself hoarse and clamouring for a rollback of the tax changes, when in fact it should look at this as a blessing in disguise. Read on to understand DFDA's contrarian and thought provoking position on what these tax law changes actually mean for the industry and reflect on some of the tough questions they say the industry must ask itself.
