Sebi set to check mutual fund payout abuse

Mutual funds can no longer use hefty pay-outs as a marketing tool to sell fund schemes. The Securities and Exchange Board of India will soon come out with a circular stating the new set of norms for dividend distribution by mutual funds.

Mutual funds will have to make the pay-out within a short time-period after the board of trustees have decided the dividend rate for a particular fund scheme.

Further, the advertisements featuring the dividend rates will also have to indicate prominently that the net asset value of the fund would come down to the extent of the pay-out after the dividend record date.

The decision was taken at the last Sebi board meeting and a formal circular to the effect will be issued soon, a Sebi official said.

Several mutual funds have been using dividends as a marketing tool to attract both corporate and retail investors.

Retail investors usually perceive dividends pay-outs as an indicator of the health of a scheme and its performance little knowing that the dividend is paid out of the existing assets and the value of units thus fall to the extent of the pay-out.

Funds also facilitate big ticket investors to engage in what is called dividend stripping. According the current laws, investments in a fund within three months of the dividend record date, will be eligible for tax-free dividends only after a lock-in period of nine months.

To escape this lock-in, and let investors the benefit of tax-free dividends, some fund companies informally tell distributors about the expected dividends exactly three months in advance.

Corpus of several dividend paying funds have thus seen huge jumps three months prior to the record date and substantial outflows subsequently.

While the new Sebi guidelines would certainly help in curbing the retail rush for dividend paying funds, the new guidelines may not be adequate to stop dividend stripping altogether.

"Since the dividend pay-out advice to distributors is usually informal, Sebi can do little to stop this practice" a fund distributor said.

Mutual funds have made aggressive pay-outs in the past couple of years. To be fair to funds, though dividends are being used as marketing stunts, they are also a smart way to protect value for unitholders in a market that has thrown caution out of the window.

As stocks climb to dizzy heights, fund managers have been playing cautiously by booking profits periodically and passing on part of the gains to investors. In all, 117 equity schemes have paid out dividends since January 2005.