Tax treatment changes rob debt funds of their sheen

Loss of indexation benefit has hit the mutual fund industry with a slowdown in product launches, the Business Standard has reported. The MF industry launched 253 schemes in the last financial year and a majority of these were fixed-income ones. This year so far 24 schemes have been launched and only three of these were debt schemes. The limited number of debt schemes has been attributed to loss of indexation benefits.

A senior MF industry person told the newspaper, “The demand in general has come down owing to a loss of indexation benefit, both from individual investors and corporates. We will look to launch products if the demand situation improves.”

Target MFs lead
Last year, target maturity funds led all the categories in terms of new launches. A total of 65 such funds were launched in 2022-23.

Target maturity funds are passive debt funds that track an index of debt instruments and are suitable for investors who look for funds that will provide fixed income. They are called target maturity funds since the portfolio bears maturity debts.

This category of funds quickly attracted the attention of retail and corporate investors. Fund managers believed that these fixed income instruments might become an alternative to the fixed deposits of banks. As the RBI battled rising inflation and pushed up interest rates, bank FDs attracted a lot of savings of the common man over the past several months.

However, from April the appetite for TMFs seem to be fast ebbing. This is clear from the inflow patterns. The inflow has been only Rs 147 crore, the lowest since December 2020. In 2022-23, the inflows had touched almost Rs 5,000 crore.

No tax breaks
Experts directly attributed the fading attraction of debt funds to long-term capital gains tax benefits being abolished for this category. “The attractiveness of debt funds has come down for sure. We are still recommending medium-to-longer horizon debt schemes but mostly to people in lower tax brackets. Products like TMFs still make sense for certain section of investors like those who want to lock in money for longer durations in expectation of capital gains,” remarked Vinod Jain, founder, Jain Investment Advisors.

Long-term capital gains taxes were earlier applicable to debt funds. Since debt funds have been denied this tax treatment from this financial year, they have lost their sheen for most investors, forcing fund houses to devise new schemes to capture the flow that used to come the way of debt funds.