Mutual fund schemes are vanishing. Nothing sinister - it's
just that fund companies are merging some schemes into others at a far higher
pace than they used to. In the first seven months of 2011, as many as 41 funds
have been merged into another one. During the previous three years, this number
was just 37.
In fact, in the five years from 2006 to 2010, there were a
total of 58 fund mergers. Looking at the current trend, 2011 could comfortably
exceed this number.
On the face of it, there's nothing wrong with this. These
fund mergers are obviously done with regulator Sebi's permission and follow all
the rules that have been put in place for investors' protection. However, fund
mergers are an unfamiliar subject for most investors, and it's useful to
understand exactly what is going on.
The first question to ask is about the need for all this.
Why do companies merge funds in the first place? The answer is simple (if
uncomfortable for the fund companies' management), they do it to bury poor
performance. In the roster of practically every Indian fund company - even the
ones with the best investment management - there are some black sheep.
These are the funds that have lost a lot of investors'
money. In my view, these tend to be flavour-of-the-month funds that were
launched during some period that was hot for a particular theme. By the time
the fund got going, the theme became yesterday's idea and the fund never did
well.
Eventually, whenever investors look at the list of funds
that the company has, it just becomes an embarrassment for everyone. A
distributor goes and pitches for a good, high-performing fund from a fund
company, the customer looks up the list of funds, perhaps on a website.
However, when the prospective investor asks questions about the duds that are
there on everyone's list, the distributor or the fund company has no answer.
Therefore, the best course for them is to merge the fund
into another one that has been showing good performance. All the investors of the
bad-performing fund are informed that the fund will be merged into another one.
They have to be given a choice of redeeming their money, or having it
transferred to the new merged fund. Either way, they are effectively redeeming
their investment from the original one.
In theory, this would lay them liable to capital gains tax
on any gains that they have made. In practice, this never proves to be a
problem. The kind of fund that is merged tend not to have ever made any profits
for their investors. And if there are no gains, then where is the question of
paying any capital gains tax?
Apart from capital gains tax, there's also the issue of
paying securities transaction tax (STT) on the transaction. However, fund
companies generally pick up the tab for STT. Or at least, they all seem to be
doing so in recent times.
Since the transaction is basically one of selling a fund and
buying into another one, the arithmetic is somewhat like that in the case of a
corporate merger. The value of your investment stays the same, but the NAV and
the number of units change. For example, let us say that pre-merger you hold Rs
10,000 in a fund with 2 of NAV and you have 500 units. If the fund being merged
into has an NAV of Rs 50, then post-transaction you'll have 200 units totaling
Rs 10,000 in value.
At the end of the day, if one of the funds you hold is
getting merged, then what it means is that you have been careless. If the fund
was such a dud that it's being merged, then you should have sold it long ago.
Source: http://articles.economictimes.indiatimes.com/2011-09-05/news/30115929_1_fund-companies-indian-fund-value-research/2
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