The risky proposal in the Budget

The managers of balanced funds keep shuffling the funds between equity and debts depending upon how buoyant the stock market are at a particular point of time. When the stock market gets overheated, it is not unusual for the fund managers to partly offload their overvalued equity holdings, and instead of sitting on cash, to invest the money in debt instruments, while waiting for the market valuations to become attractive again. This shuffling of portfolio, while reduces the risk, also creates short-term profits for the funds. Individual investors are usually not competent to take advantage of such situation and they seldom manage to get in and out of the market at appropriate time.

While most balanced funds generally have as much as 60-65 per cent of their assets allocated to equity, the very ability to shift from equity to debt whenever they want it is a great strategy. The budget move to peg the equity allocation to 65 per cent shall rob such funds of this ability.

Does this make balanced equity funds less attractive? Yes and no. Yes, for the reasons cited above, no, because of the advantage these funds still enjoy over the direct investment by individual investors. The advantages are many.

First, in spite of higher allocation to equity, balanced funds still have an ability to keep rejigging their portfolio continually moving in and out of equity or debt depending upon the market situation, a competence that the individual investors may not have.

Second, the tax advantage. While long term capital gains is exempt in respect of all investors, individual investors pay 10 per cent short term capital gains when they sell off their holdings within one year. Balanced funds do not pay such tax, with the result that the value addition is higher if a fund rather than an individual investor makes the sale.

Third, in spite of higher allocations to equity stipulated in the Budget, funds still have a 65:35 ability of manoeuvrability, which at the hands of competent managers is still a large flexibility.

Close-ended and open-ended mutual funds to be on par:

The move to bring close-ended mutual funds at par with the open-ended funds is a great step towards creating a long-term sustainable market. Closed ended mutual funds, by their very definition are long-term instruments. It means an assured availability of funds in the hands of the fund managers for a longer term, thus enabling them to concentrate on long term investments, as compared to the short term funds which face the redemption pressure in a volatile market, usually at the very time when they need more funds.

Empirical evidences the world over have proved that in order to maximise the returns, investment in equity should be made for a longer time horizon. Encouraging close-ended funds would mean shift in emphasis from short term to less volatile and more certain long term.

Since they do not have redemption pressure, close-ended funds can concentrate better on maximising the long-term gain of the investors, unlike the open-ended funds who are forced to play the short-term game so that they can continually impress the investors.

Electric Platform for debt market:

The extension of the NDS OM electronic bond-trading platform to mutual funds and provident funds is a great proposal. The proposal to bring the corporate debt market on the electronic platform would also have great effect on liquidity. Both these measures are likely to pave the way for as strong a debt market as the present equity market.

Key issues not addressed:

There are a couple of key areas which the investors would have expected the Finance Minister to address but the Finance Minister decided not to touch upon.

First, the budget is silent on real estate investment trusts (REITs). REITs have been the talk of the industry for some time, with both investors and the fund houses awaiting some clarity. With the present boom in real estates the retail investors are eager to participate in the real estate boom, but have not been able to do so because of the complexities involved in real estate deals, and also because of high value of transactions, and high associated transaction costs. Such instruments are very popular in the Western markets. It seems Indian investors will have to wait for some time before they can broaden their asset allocation to include real estate funds.

Secondly, another investment avenue that investors were expecting in the budget was the gold exchange traded fund (ETF). As a matter of fact, the expectations regarding such funds were high, because the Finance Minister had referred to them in the previous Budget, and with gold heading northward, retail investors were eager to participate in the profitability arising from the rising gold prices. This was a surprise omission in the Budget. The omission of this item was much like the omission of the EET taxability of investments about which the Finance Minister spent a considerable time in the previous Budget, but conveniently decided to omit any reference to it in this Budget.

Third, while the Finance Minister has extended the Section 80C tax benefit to fixed deposits, one fails to understand why such benefits were not extended to similar instruments issued by mutual funds. Placing such instruments in the tax rebate category could motivate investors to participate in debt market with more enthusiasm.