Mutual Fund: A Pinch for Mutual Funds

It is quite likely you invested in a mutual fund scheme through an agent, distributor or your bank’s wealth management advisor. All these players in the mutual fund distribution chain provide a service to the end-customer and hence need to be paid for by the mutual fund management company. Since their services are liable to Service Tax, till now they had been invoicing for their services with tax at this rate. Come July 1, they will start to raise bills with a GST rate of 18%. This is going to add to the expenses of the mutual fund management companies, which in turn will need to be met from the management fees & expenses charged from the investors.

Will the asset management companies decide to absorb this additional levy? That remains a million-dollar question. But the general sense seems to be that the impact of the levy will be passed on to the investors. Hence, the expense ratio of your mutual fund scheme will likely see a nominal increase. To put this in perspective, the expense ratios of mutual funds range between 1.25% to 2.75%. A 3% increase on these numbers translates into a rise in expense ratios to between 1.29% to 2.83%. In other words, the impact on your returns would be between 0.04-0.08%. This expressed in terms of rupees on an investment of Rs 10,00,000 will translate into not more than Rs 800.

While every additional expense is a cost, the increase is not significant enough for you to start selecting mutual fund schemes to invest in, based primarily on their expense ratios. Your investment decisions should be driven by your investment objective and the performance of the scheme and asset manager. There is little reason to invest in a scheme where the objective isn’t aligned to your needs even if the expenses are lower.

That said, mutual fund schemes that are not actively managed by asset managers, like index funds have a lower expense ratio. And given that these tend to track the performance of indices closely, putting some of your equity allocation into such funds may not be a bad idea. While selecting an index fund, keep an eye out for the expense ratio as well as the tracking error—this indicates the degree of variance of the scheme’s performance vis-à-vis the base index. An index fund with a low tracking error will more closely mirror the index’s performance. From an asset class perspective, remember mutual funds are merely instruments to help you invest in different asset types—equity and various kinds of debt instruments, there might be some implications for those putting their money in growth funds (equity focused mutual funds). GST is expected to help improve tax efficiency in the medium to long term for organised businesses. This will likely translate into savings for companies and higher profitability, which in turn should translate into higher earnings per share for shareholders and consequently higher stock prices, other things remaining the same.

An investment in equity funds might therefore be a good option. The initial stress of compliance and uncertainty might offer a good opportunity to cash in on gains once the process stabilises. A systematic investment plan (SIP) in an index fund can be a possible option to kill two birds with one stone—invest for the upside while addressing the impact of higher expense ratios.

Happy investing through GST!

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