Are unprofitable AMCs safe?

Is investing in the funds of unprofitable asset management companies (AMCs) safe?

-Aditya Sharma

Your investments in mutual funds are not going to be directly affected by the profitability, or lack of it, of the AMC. In the worst case scenario, when the company has to wind up its business, it will liquidate its assets and distribute these among the unit holders at the applicable NAV.

At present, a few AMCs are profitable. This is a business where income accrues from the assets managed by the company. It takes time for a company to acquire sufficient asset size to break even. However, if a company stays unprofitable for a long time, it might cause upheaval in the management, and is a factor worth looking at while investing.

Why is it that the growth in net asset value (NAV) of income funds is not the same as that of prevailing interest rates? And, what’s the reason for the huge differences in returns of the top and the bottom performers?

-Haridas T

The returns for debt funds not only accrue from the interest income, but also from the price movements of fixed income instruments. While liquid funds derive most of their returns from interest income, short-term and medium-term debt funds primarily generate returns from trading of fixed income instruments, based on their assessment of the interest rate scenario. This also causes the return differential between different income funds.

I have invested in the post office monthly income scheme (MIS) for a monthly income. Can monthly income plans (MIP) in mutual funds give me higher guaranteed returns than the MIS, along with capital appreciation?

-Nitin Kanungo

Do not invest in MIPs if a guaranteed income is your priority. MIPs will invest about 10–20 per cent of their portfolios in equities, and are like conservatively positioned funds. Despite a portfolio primarily in fixed income instruments, there may be intermittent declines in the value of their investments.

Their equity portion helps them better the performance of pure debt funds in rising equity markets. In a time frame of more than three years, they can give you better returns than other debt investments and help beat inflation in a relatively stable manner.

The proposed New Direct Tax Code 2009 says ‘any income received in respect of the units of a mutual fund’ is ‘income not included in the Total Income’. Does this mean that if this tax code becomes applicable, all gains from a mutual fund will be tax-free?

-Anand H Bhagwat

Gains from mutual funds are divided into two parts: dividends and capital gains. Income in mutual funds refers only to the dividends distributed and does not include the capital gains.

Currently, all dividends from mutual funds are tax-free in the hands of the investor. However, dividends from funds other than equity funds are subject to dividend distribution tax (DDT). This will continue to be so. The capital gains will, however, be added to a person’s income and taxed accordingly.

Is it possible to switch from a growth option to the dividend option of the same ELSS while my investments are still locked-in?

-Easwer Chinnadurai

It is not possible. A switch between the growth option and the dividend option amounts to redemption from one option and fresh investment in the other. The only switch allowed during the lock-in period in an ELSS is between dividend payout and dividend reinvestment.

Value Research