Somebody’s pain is Somebody’s gain

Five seconds of Finance Minister’s budget speech has changed the landscape of mutual fund for ever.  It was like a bolt from the blue which has far reaching implications and complications all stake holders - fund houses, investors, companies and distributors.

1. The word Fixed Maturity Plan (FMP) will be found only in the web pages in the next few months. The current lot of investors will tell the future lot the sweet (and effort less) success they has with these plans.
2. While numbers vary but close to a lakh crores will be taken off from the FMPs and a similar amount from the short term funds. The mutual fund (MF) industry which recently touched an AUM size of 10 lakh crores will be offset by more than 20%.  Even assuming a worst case margin of 10 bps, the fund houses cumulatively loose over Rs. 200 crores in profit. Hopefully, the increase in equity book should compensate for this loss.
3. On the positive side, the fund houses will now increase their focus on selling long term solutions diverting the disproportionate efforts spent on liquid, FMP and short term products.
4. Since it is difficult for investors to choose a fund category for three years, the immediately implication could be a rush to Credit opportunity funds. Since the optimal size of such funds is limited, the worry could be that the mutual funds could go deep down the credit risk which could entail greater risk at a later date. They could also lap up any corporate deposit that may hit the market with a pre-tax double digit return.
5. The investors may also move towards Dynamic debt funds with a three year horizon as they are best positioned to maneuver the view on the market. Atleast now, the dynamic funds will be compared with post tax returns from competing products and not the currently existing practice of comparing with income funds when market is good and liquid funds when the market is bad.
6. The interest could increase in Financial planning products. This is because the cost of rebalancing has increased for an investor and there is no cost incurred by these products in rebalancing.
7. Since Arbitrage funds enjoy equity taxation, the dividend plans of these funds will increase in size. Companies and individuals will target these funds for their short term investments. However, the market size for arbitrage is small and hence the scalability of these funds is limited.
8. Due to the reduced participation (or even absence) from the corporate, the expense ratios of short term funds might increase. Until now, the companies were keeping them in check and it will be nearly impossible for the fragmented retail participation to influence them.
9. The distribution fraternity has been massively hit. It started with the global financial crisis in 2008 which put a spanner in their dream run of garnering assets and earning high commissions. In 2009, it was followed by the ban of entry load in MFs and reduced commission in insurance products. In 2013, the direct plans were introduced which took corporate away from distributors. In the mid of 2013 was the event of 15/07 when the RBI increased overnight rates sharply. Just when things were stabilizing 10/07 happened. The finance minister administered a new dose of medicine. The institutional side of the business may have to be restructured further.
10. Mutual Funds’ pain is banks’ gain. The lazy banking will benefit at the cost of FMPs and short term funds. This could result in banks cutting deposit rates and inturn improving their NIMs. Assuming NIM of 2.7% on the two lakh crore that would move out of mutual funds into the banking system, the net interest earned will go up by 4,000 crores adjusted for statutory requirements.
11. The biggest gain is for the government. Assuming an average of 20% tax rate on the two lakh crore that would move out of mutual funds which could yield about 9%, the tax coffers will increase by over 3,600 crores. If we include the tax paid by the banks on additional income, the tax coffers would bloat by over 4,000 crores.