Mis-selling, dividend tax change spur outflows from hybrid funds

Balanced or aggressive hybrid funds saw sustained outflows last year as subdued performance and mis-selling led investors to pull out money.

Last year, the category saw outflows of over Rs 24,000 crore, data from the Association of Mutual Funds in India (Amfi) shows.

“Balanced funds were sold and misunderstood as ‘safe’ products. Last year’s market crash, however, led to significant capital erosion, which prompted investors to move out of such funds. A lot of investors had also invested on the premise that they would get consistent dividends, which did not materialise,” said Amol Joshi, founder, Plan Rupee Investment Services.

The funds were also mis-sold by distributors, especially by a number of bank branches, which sold them as products that could provide consistent dividends, said people in the know.

The performance of these funds improved in the past few months with the significant run-up in the market. In the last one year, aggressive and balanced hybrids have provided returns of 14.1 per cent and 11.2 per cent, respectively. However, outflows have continued, with December seeing outflows of over Rs 3,900 crore, the highest in 2020.

The other reason the fund has seen outflows is the change in the way dividends are taxed. Last year’s Union Budget made dividends taxable in the hands of investors, which would get added to their income to be taxed according to their slab rates. This would especially be a negative for someone in the 30 per cent tax bracket. This is one reason why, industry experts reckon, that these funds saw significant outflows from larger investors.

In the earlier regime, equity fund dividends faced a dividend distribution tax, or DDT, of 11.65 per cent and debt fund dividends faced a DDT of 29.12 per cent (including surcharge and cess). Once DDT was deducted, the dividend was tax free in the hands of the investor.

“The change in the way dividends are taxed last year has impacted these funds. Also, investors that were not happy with the fund performance have chosen to exit,” said NS Venkatesh, chief executive officer, Amfi.

Hybrid funds predominantly invest in equity and debt. While equity has the potential of generating higher returns over longer periods, debt as an asset class can help generate regular income.

Balanced hybrid funds invest a minimum of 40 per cent and a maximum of 60 per cent in both equity and debt. The aim is to generate long-term capital appreciation through investment in the equity and balance the risk through debt allocation.

Aggressive hybrid schemes mandate investment of a minimum of 65 per cent and a maximum of 80 per cent in equities and 20-35 per cent in debt. The aim is to provide higher returns at reduced risk through the smaller allocation to debt. These schemes benefit from taxation applicable to equity-oriented schemes.