Interest in income funds

FUND QUERIES

Change in the interest rate on small savings has no bearing on the returns of income funds.

If the government reduces the interest rate on PPF and other postal savings, do you think income funds will be affected? - Anthony D'Souza

There is no direct co-relation between the return of income funds and administered products such as Public Provident Fund and postal-saving schemes. While the latter are determined by the government, the returns of income funds are market-determined.

However, what has happened in the past is that a reduction in the small-savings rates has had a positive impact on the bond market. Market participants view the reduction in rates as a signal from the government that it is committed to a lower interest rate regime. At the same time, it also shows that the government is determined to move towards a market-determined system of interest rates.

From the macroeconomic viewpoint, a reduction in the small-savings rate reduces the interest burden on the government. A lower fiscal deficit is viewed as a positive, which can help in keeping interest rates low. In the past, when the rate of small-savings was reduced, income funds witnessed a partial spurt in returns. A 1 per cent point reduction in the PPF rate in January 2000 led to a bond market rally.

The average debt fund gained 1.58 per cent. In comparison to this, in the previous month (December 1999) the average gain was 1.19 per cent. At other times, such as February 2001 and February 2002, the reductions in these administered rates were followed by other developments such as the reduction in the bank rate.

These 'other' events have had a more direct bearing on the debt market. So a change in the interest rate on provident funds and other small-savings instruments has no bearing on the returns of income funds and other mutual funds. To the extent that changes in these rates affect debt markets, they affect these funds. And that's to a very small extent.

I invested in a Nifty index fund. From time-to-time, I read that many of the companies here declare dividends. But I have not got any dividends till date. Where do these dividends go? - Ruby Mathur

You are correct in that most of the stocks in the Nifty or the Sensex do declare dividends. However, the dividend declared by the index as a whole is not much.

The dividend declared by stocks that the fund holds go back into the fund. This is reflected in the NAV. But because the quantum of dividends is very low, the dividend declaration does not result in a significant appreciation. For instance a Nifty index comprises of 50 companies. At any given point of time only a handful would declare dividends. And hence the total effect on the fund's NAV will not be very significant.

As to when will you get the dividend, it is dependent on the fund you have invested in and the option you have chosen. Many index funds do not have a dividend option. This means that any gains you wish to take will have to be obtained by redeeming the units. And the dividend declared by the inherent companies will appear as an increase in NAV. If you are invested in the dividend option of an index fund, you can wait for the scheme to declare dividends.

I invested in Franklin India Bluechip Fund (dividend option) at different levels. Now that the NAV has risen, I plan to book some profits and rebalance my portfolio. But I can't figure out which of the units will be redeemed. Will it be earlier investments or the later ones? How will I figure out the value of my investments after partial redemption? - Deepti Mukherjee

Your query reveals that booking profits is not an easy exercise at times. From the investment details you have supplied, you own a total of 3,763 units of Franklin India Bluechip Fund. We gather that you wish to redeem profits of Rs 1,23,135 from the current valuation of Rs 1,63,635.

As a first step, you can redeem units by filling in a redemption request for the sum of Rs 1,23,135 and the fund would deduct the necessary number of units. But as an informed investor it is always good to be in command of one's investments. So here goes.

Investments and redemptions in mutual funds follow a principle called first-in first-out (FIFO). This means that the investments made first will be the first to be redeemed and so on. In order to book profits of Rs 1,23,135, you will have to redeem a certain number of units. At an NAV of Rs 43.48 per unit, you will have to redeem 2,832 units. On the basis of the FIFO principle, the first batch of units to be redeemed will be those purchased first and then the next batch and so forth and so on. Hence units purchased on

February 8 (412.201), September 12 (90.09), September 19 (465.983) and October 1 (717.017) will be the first to go. The only purchase that will be partially diluted is the 1,150 units purchased on October 4, 2002. Of this you will end up retaining only 3.82 units.

As for the status of your remaining investments, the balance units will be maintained with the fund house until you wish to redeem them. And these units will be the most recently purchased ones totaling 931.46 units i.e. 3.82 units from October 4 and 927.644 from the purchase made on October 18.