The Hindu Business Line : Dividend abuse will not pay

MUTUAL FUNDS ARE increasingly using dividend announcements to lure investors. Setting a record date for determining the eligibility for receiving the dividend is the key element of this strategy. As the dividend payout leads to an equivalent drop in the NAV (net asset value), the exercise only creates the illusion of leaving investors with an income. This may be beneficial to investors willing to wait out the prescribed three-month lock-in, book a capital loss and lower their tax outgo. The three-month period is not deterrent enough, especially in a situation, as now, when fund houses have been declaring hefty dividends, ranging from 20 per cent to 100 per cent.

The entry and the rapid exit of individuals with only the tax advantage in mind can be detrimental to long-term investors in the fund. Also, with such episodic cash flows, fund managers may end up taking sub-optimal decisions on the portfolio. The higher cash position may also act as a drag on performance. The Securities and Exchange Board of India now requires fund houses to point out that the NAV would decline by a sum equivalent to the dividend, but that is not a solution to the problem; most often this warning is tucked away in the fineprint of the promotional campaigns. The recent spate of dividend proposals with prospective record dates may be partly linked to the dividend tax exemption available till March 31. But it has surely become a tool in the hands of fund houses to mobilise monies. In quite a few funds the asset base has swelled based on such dividend payouts. Unfortunately, fund houses are neither doing themselves nor their investors any good by sourcing funds through this bait. Thus, even the few funds with an impressive long-term track record of consistent performance and most peer funds across quarters have taken the dividend route. Their reluctance to market their offering on the basis of the record of performance rests on flawed assumptions about investor behaviour. A study of asset base of funds over the past couple of years suggests that investors do track funds that do well consistently and invest in them. It is such flows that fund houses should seek, as they are likely to stay on longer.

SEBI should insist that mutual funds do away with the concept of prospective record date so that dividend announcement is not exploited for mobilisation. This would also ensure that the device is not used by high net worth investors for short-term tax advantage. Fund houses must be required to report their asset base on the date of the declaration of intent to announce a dividend, on the record date, and, also on the expiry of the three-month lock-in period designed to discourage to dividend stripping. This will enable investors form an informed view of the effect of the dividend exercises on performance. Such requirements ought not to discourage fund houses from dividend payments as the latter is an effective tool to lock in on at least a part of the gains that would otherwise remain on paper.

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