MFs see silver lining in tax hike: Higher tax could lead to longer holding periods for investors

While presenting the Union Budget, Finance Minister Nirmala Sitharaman proposed increasing the tax on LTCG from 10 percent to 12.5 percent and the STCG from 15 percent to 20 percent.

While the stock market seems to be shrugging off the hike in capital gains tax on equities, mutual fund companies are hopeful that the increase in the long-term capital gains tax rate could actually result in investors adopting a longer-term view to minimize the tax impact.

In an interview with Moneycontrol following the budget announcement, A Balasubramanian, MD & CEO of Aditya Birla Sun Life AMC, noted that while the hike was not in line with market expectations, it could still have a positive impact on the mutual fund industry. “An increase in short-term capital gains tax by five percent might lead investors to hold their assets longer, which could be beneficial for the equity and mutual fund markets," he said.

While presenting the Union Budget on July 23, Finance Minister Nirmala Sitharaman proposed increasing the tax on LTCG from 10 percent to 12.5 percent and the STCG from 15 percent to 20 percent.

Edelweiss’ Trideep Bhattacharya said that for a two-year holding period, investors will see an impact of 1.25 percent per annum on the total returns; as the holding period is longer, the impact will continue to diminish. “Typically, investors should aim to hold their equity investments for 3 to 5 years. Considering a 5-year holding period, under the revised tax-rates, a 2.5 percent impact (12.5% versus 10%) over this time would result in "lower returns" by 50 basis points per annum. This 50 basis points per annum reduction is relatively minor and does not significantly influence investment decisions, as equity investors generally aim for double-digit returns from equity markets,” explains Bhattacharya.

Karthik Kumar, Fund Manager at Axis Mutual Fund, said that while investor behavior might adjust somewhat to these changes, he added that taxes are typically one of many factors influencing investment decisions. "The increased cost of short-term trading could lead some investors to hold investments longer, but this would be just one of several considerations," he said. He also noted that the increase in short-term capital gains tax to 20 percent seems intended to encourage longer-term investments by making short-term trading more costly.

"This measure aims to dissuade frequent market churning, thus impacting shorter-term retail trading strategies while incentivizing a longer-term investing culture,” he said.

Besides, Kumar said, "While the tax hike does slightly affect investors, it's not a game-changer, especially considering typical holding periods and market returns."

ITI AMC's Mayukh Datta concurs. "Possibly, people will now invest for a longer period. This extra tax, which they have to pay, diminishes in impact if you hold the investment for a longer time," he explains, adding that the chances of achieving above-average returns are higher with a longer holding period.

A fund manager who wished to remain unnamed agreed that this could add to the stickiness of investors but added that this was a rather "optimistic view." He said, "It could make people think through whether the cost of moving to another fund is justified or if they should consider another product. We're not saying it will definitely happen, but it could encourage more long-term investment."

Overall, fund managers say that the tax changes do not impact the core strategies of mutual funds. "The emphasis remains on encouraging longer-term investments, with 'long term' typically meaning a holding period of three to five years, depending on the strategy. The focus will remain on encouraging investors to stay through market cycles rather than timing the market or sectors," says Kumar.

Indian mutual funds continued to see inflows across funds. Currently, there are about 8.99 crore (89.9 million) SIP accounts through which investors regularly invest in Indian mutual fund schemes. The total amount collected through SIP during June 2024 was Rs 21,262 crore, up from Rs 20,904 crore in May 2024 and Rs 20,371 crore in April 2024. Assets under management (AUM) of the mutual fund industry reached Rs 61.16 lakh crore in June.

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