A debt plus arbitrage investment may be tax-friendly, but can dampen returns, cost you more However, remember that this shift affects the fundamental risk-return profile of a debt mutual fund and may lead to a change in returns, especially in volatile markets. This is why investors should first assess if this aligns with their needs before buying into it
The plain-vanilla debt fund may be undergoing a makeover. With the revised tax rules for debt fund gains turning investors away, mutual fund houses have started repackaging select debt schemes to make these tax-friendly. Specifically, AMCs are now combining fixed income with arbitrage under the fund of funds (FoF) category. Some debt schemes from fund houses like Aditya Birla Sun Life AMC, Axis AMC, Bandhan AMC and Kotak AMC have been repackaged in this manner. Other AMCs are also planning to convert debt schemes into this newer avatar or launch fresh ones.#sr_widget.onDemand p, #stock_pro.onDemand p{font-size: 14px;line-height: 1.28;} .onDemand .live_stock{left:17px;padding:1px 3px 1px 5px;font-size:12px;font-weight:600;line-height:18px;top:9px} #sr_widget.onDemand .sr_desc{margin:0 auto 0;} #sr_widget.onDemand .sr_desc{color: #024d99;margin-top:10px;} #sr_widget.onDemand .crypto .live_stock .lb-icon{8px 6px 5px 3px !important} #sr_widget.crypto.onDemand a.text{border-bottom:1px solid #ccc;padding-bottom:5px;display:block;width:100%} #sr_widget.onDemand .sr_desc .text p, #stock_pro.onDemand .sr_desc .text p{font-size:12px;font-weight:400;}
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Should you make this switch in your portfolio? To make a decision, find out how these funds differ.
Tax-friendly option
These schemes will essentially invest less than 65% of their corpus in fixed income, while the rest will be parked in arbitrage positions. Arbitrage involves taking positions simultaneously in the cash and futures segments of a security to take advantage of the price differential between the two.Under this fund structure, gains are taxed at 12.5% if held for more than 24 months. On the other hand, gains from a traditional debt fund are taxed at the investor’s slab rate, irrespective of the holding period. This makes the latter tax-inefficient for those in the 20% or higher tax slabs. A pure debt fund fetching an 8% annualised return after two years will translate into a post-tax gain of 5.7% for an individual in the 30% tax bracket. A debt-cum-arbitrage fund clocking the same return will net the investor 7% post-tax gain. This makes the latter an enticing proposition. “Debt funds have suddenly become tax-inefficient, making other avenues more appealing for investors,” observes Vidya Bala, Head of Research, Primeinvestor.in.
Risk and gain
However, this tax benefit will have some trade-offs for the investor. Be mindful of how the new avatar changes the core risk-return profile of a pure debt scheme. Adding arbitrage in the portfolio is a change in the scheme’s fundamental attributes. To be sure, running arbitrage is typically a riskfree strategy. However, returns from arbitrage tend to ebb and flow depending on the market volatility and direction. Weakness in the equity markets may lead to drying up of spreads between the spot and futures markets, diluting the returns.a:hover{text-decoration:none;} .liveEventMain_widget{margin-top:15px;padding-top:24px;border-top:2px solid #000;position:relative;font-family:Montserrat;} .liveEvent_slider{position:relative;overflow:hidden;} .liveEvent_slider ul{white-space:nowrap;list-style:none;margin-top:12px;} .liveEvent_slider ul.sliderContainer{margin-bottom:30px;} .liveEvent_slider ul li{white-space:normal;width:282px;vertical-align:top;display:inline-block;margin-right:12px;border-radius:12px;box-shadow: 0px 4px 12px 0px #2407461F;background-color:#fff;overflow: hidden;} .images_wrap{position:relative;} .images_wrap .cover_img{object-fit:cover;object-position:center;border-top-left-radius:4px;border-top-right-radius:4px;} .images_wrap .author_img{position:absolute;left:10px;top:13px;border-radius:10px;} .images_wrap::before{background-image: linear-gradient(180deg, rgba(11, 11, 46, 0) 20.31%, rgba(11, 11, 46, .6) 61.46%, #0b0b2e);content: "";height: 100%;left: 0;position: absolute;right: 0;width: 100%;} .liveEventMain_widget .details{padding:12px;} .liveEventMain_widget .category{font-size:12px;line-height:14px;font-weight:700;color:#6a11b0;margin-bottom:8px;} .liveEventMain_widget .course_name{font-size:16px;line-height:20px;font-family:Faustina;-webkit-line-clamp:2;overflow:hidden;height:40px;display:-webkit-box;-webkit-box-orient:vertical;font-weight:600;color:#000;} .liveEventMain_widget .details .author_name{font-size:13px;line-height:16px;color:#333;font-weight:400;margin-top:4px;-webkit-line-clamp:2;overflow:hidden;height:32px;display:-webkit-box;-webkit-box-orient:vertical;} .liveEventMain_widget .view{border: 1.5px solid #D51131; display: block; padding: 8px 0; text-align: center; border-radius: 4px; font-size: 14px; line-height: 16px; color: #D51131; margin-top: 12px; width: 100%; font-family: Montserrat; font-weight: 600; cursor: pointer;} .liveEventMain_widget .view span{display: inline-block; width: 6px; height: 6px; border-top: 1.5px solid #ed193b; border-left: 1.5px solid #ed193b; transform: rotate(90deg); position: relative; left: 5px; top: -2px;} .liveEventMain_widget .view span::after{content: ''; display: inline-block; width: 11px; border-top: 1.5px solid #ed193b; transform: rotate(45deg); position: absolute; top: 3px; left: -2px;} .liveEventMain_widget .arrow_btn{width: 26px; height: 25px; position: absolute; z-index: 11; background-size: 312px; cursor: pointer;} .liveEventMain_widget .nextprev-btn{display:inline-block;width: 100%; position: absolute; top: 59%;} .liveEventMain_widget .prev-btn{background-position: -212px -2px;left: -12px;} .liveEventMain_widget .next-btn{background-position: -241px -2px; right: -3px;left:unset;} .liveEventMain_widget .arrow_btn.disable{opacity:0.5;} .liveEventMain_widget .ts-dots{display:inline-block;position:absolute;top:34px;right:10px;} .liveEventMain_widget .ts-dots ul{display:inline-block;} .liveEventMain_widget .ts-dots li{width:7px;height:7px;border-radius:50%;background-color:#cdcdcd;margin:0 2px;display:inline-block;} .liveEventMain_widget .ts-dots li span{display:none;} .liveEventMain_widget .ts-dots li.active{background-color:#ed193b;} .liveEventMain_widget .topContain { display: flex; align-items: center; gap: 6px; } .liveEventMain_widget .topContain .imgBox { max-width: 40px; } .liveEventMain_widget .topContain .logoTitle { font-family: "Montserrat", "Verdana"; font-weight: 700; font-size: 20px; line-height: 100%; } .liveEventMain_widget .topContain .logoSubTitle{ position: relative; font-size: 18px; font-weight: 500; line-height: 1.2; color: #747474; margin-left: 24px; } .liveEventMain_widget .topContain .logoSubTitle:before{ content:''; position: absolute; left: -13px; top: 0; width: 1px; height: 100%; background-color: #838383; } .liveEventMain_widget .liveEvent_slider .liveEventCardContainer{ } .liveEventMain_widget .liveEvent_slider .liveEventCardContainer .liveEventCard{ display: flex; } .liveEventMain_widget .liveEvent_slider .liveEventCardContainer .liveEventCoverImg{ }
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Juzer Gabajiwala, Director, Ventura Securities, says, “Arbitrage typically fetches 6-7% return, but when the market conditions turn sour, returns can drop below 4%.” This may put a lid on fund returns. Bala says, “Don’t expect the arbitrage component to generate return for you. It is only meant to keep the risk profile low. It is the debt portion that will have to drive the return.”How your tax liability changes
Investors should also consider the tax benefit before opting for a shift in profile.
A pure debt fund typically thrives in a falling interest rate environment. Bond prices and interest rates are inversely related. When rates fall, bond prices rise, and vice versa. The bonds with longer tenures particularly gain sharply in this phase. The bond funds mentioned earlier, for example, invest across short- to long-duration bonds to capture various phases of the bond market cycle. However, in this new avatar, with less than 65% of the corpus parked in bonds, the fund will not capture the capital appreciation entirely from softening interest rates. This may keep the returns from the fund muted even when the market conditions favour the core bond portfolio. Bala argues, “Whatever the fund can do, it must do in the 65% debt allocation. The exact strategy pursued within this portion will determine whether the fund will deliver good returns.”
Any incremental tax benefits from switching to this strategy may be negated if the fund is unable to capture opportunities from interest rate cycles. “On the flip side, the arbitrage position may actually cushion the fund when interest rates don’t move as expected,” points out Gabajiwala.
Besides, debt funds repackaged as FoFs will come at a slightly higher cost for investors. Apart from paying an expense ratio for the main fund, they will also incur expense ratio of the underlying funds.
Should you switch?
For most investors, avoiding higher tax liability in investments remains a constant pursuit, but it often induces unnecessary portfolio changes. When tax rules for debt funds changed in 2023, many shifted to hybrid funds for their superior tax efficiency. In a bid to escape taxes, investors invited unwanted risk in their portfolios. Those considering switching to income-cum-arbitrage as an alternative to pure-play debt funds must assess if the shift in risk-return profile aligns with their needs.Those simply seeking to park surplus in a safe avenue may consider the newer funds for the added tax efficiency and better stability. “It is a good alternative if you want lesser volatility than a duration-oriented debt fund (longer tenure bonds),” says Gabajiwala. The investors seeking to make the most of interest rate cycles are better off sticking to a plain-vanilla debt fund, maintain experts.
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This story originally appeared on: India Times - Author:Faqs of Insurances
