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Bonus just in name, not in spirit

Bonus just in name, not in spirit
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First Published: Mon, May 02 2011. 09 10 PM IST
Updated: Mon, May 02 2011. 09 10 PM IST
On 25 April, UTI Asset Management Co. (AMC) Ltd issued bonus units in three of its schemes—UTI Unit Linked Plan (Ulip), UTI Children’s Career Plan – Balanced (CCP) and UTI Retirement Benefit Pension Fund (RBP). The bonus units were declared in the ratio of 1:10. In simple terms, it means that unitholders of these schemes would get one unit as a bonus unit, for every 10 units they held in these schemes.
In an era where dividends are the preferred choice of giving payouts to investors, most fund houses have chosen to avoid paying bonus units to investors. As per data provided by Value Research, a mutual fund (MF) tracking firm, only two fund houses have declared bonus units in the past two years, most notably UTI AMC. While UTI Top 100 declared a 1:1 bonus unit in June 2009 (1 bonus unit given for every one unit held in the scheme), Canara Robeco Equity Diversified Scheme offered 0.09:1 bonus (0.09 units offered for every unit held in the scheme) in October 2009, under its bonus plan.
Tax status
Bonus units, like dividends, are another way of paying back investors. “However, bonus units are still units at the end of the day and you hold more units. In case of dividends, cash comes in my bank account,” says Ashvin Parekh, partner, national leader – global financial services, Ernst and Young Pvt. Ltd.
The net asset value (NAV) falls after bonus units are declared just as they do when dividends are declared. So if the fund declares bonus units in the proportion of 1:1, the NAV falls by half.
Assume two investors, Khushru and Adil invest Rs 25,000 each in an MF scheme at an NAV of Rs 25. Both investors get 1,000 units. On 1 February, assume that the scheme declares a bonus of 1:1 (one bonus unit for one unit held). Both investors would get additional 1,000 units; the total number of units each of them would now hold will go up to 2,000 units. Given that the bonus was 1:1, the NAV would come down by half; the present NAV would now be Rs 12.5 (half of Rs 25). The value of the both investors’ portfolios would, therefore, remain the same; Rs 25,000 (2,000 units x Rs 12.5).
In this case, so far, the bonus did not make a difference as the total value of the portfolio remains the same. The difference comes when you try and sell your units. On 31 March, the NAV goes up to, say, Rs 14. Assume both investors try and sell 400 units on that day. Both realize Rs 5,600 (400 units x Rs 14 NAV). The only difference: while Khushru sells his original units (bought at Rs 25), Adil sells his bonus units (that he was allotted for free). Khushru makes a loss of Rs 4,400, but Adil makes a gain of Rs 5,600 because cost of acquisition of bonus unit is nil.
If this scheme is a debt scheme, Adil’s gains after tax come down to Rs 3,869.6 (30.9% short-term capital gains tax including cess, assuming Adil is in the highest tax bracket). If it’s an equity scheme, the gains after tax come down to Rs 4,734.8 (15.45% short-term capital gains tax, including cess).
Why give bonus units
Bonus units were popular in the early 1990s, typically with public sector fund houses as also some old-time private sector fund houses such as the erstwhile Pioneer ITI AMC, which later got acquitted by Franklin Templeton AMC (India) Ltd and JM Financial Asset Management Ltd. This was a time when investor awareness was low and when fund houses would have you believe that you were getting something extra by way of bonus units.
The popularity of bonus units shot up after Budget 2002 made dividends of debt funds taxable in the hands of investors. Fund houses then launched bonus plans (in addition to dividend and growth plans that were already existent then). These bonus plans were mooted by various funds for investors looking for some kind of regular return. So instead of declaring dividends, which would be taxed proportionately in the hands of the investors, MFs began declaring bonus units under this plan. In this case, investors (like Khushru in our example) would redeem principal units soon after a bonus is declared (and NAV falls), book a loss and then sell the bonus units after a year and pay 10% long-term capital gains tax. The plan was short-lived as just the next year (in 2003), the government restored dividend distribution tax to 12.5%.
Do they make sense?
Though most funds houses now avoid declaring bonus units, UTI AMC remains perhaps the only fund house that still declares bonus units almost once a year. “Not everything should make economic sense. Sometimes, our actions must also make emotional sense. We have realized that bonus resonates well with many investors and our feedback told us that if we don’t issue bonus for some time, investors call us and wonder why we haven’t yet issued bonus units,” says R. Raja, head (products), UTI AMC.
One problem is that since the cost of acquisition of bonus is considered nil (these units are created, not bought), investors unknowingly sell these units before they complete a year and end up paying a capital gains tax (assuming the NAV goes up).
But Parekh says there is merit in UTI declaring bonus units as the funds in which the AMC declares bonus units are typically long-term schemes. While UTI CCP is a scheme that parents invest in for their kids till they need funding for their higher education or marriage, UTI RBP is a retirement scheme that offers tax deduction benefits; the scheme expect investors to remain invested till they complete 58 years of age. “If the investor is staying invested for a really long term, it doesn’t make much of a difference whether s/he is getting dividends in cash or bonus in terms of units,” Parekh adds.
Not all agree though. Akshay Gupta, chief executive officer, Peerless Funds Management Co. Ltd is averse to the idea of issuing bonus units in Peerless MF Child Plan, a debt-oriented scheme that will also partially invest in equities and gold. “Apart from the psychological sense that the NAV goes down after bonus units are issued, bonus doesn’t make sense. In fact, even dividends are psychological; they come out from your own pocket and the NAV drops, thereafter. These are just gimmicks to bring the NAV to a more manageable level,” he says.
A product head of a private sector fund house, who cannot be named, adds: “When companies declare bonus units, it can make a positive difference to investors. If the company declaring bonus is well-managed and perceived to be a good one, sentiment can soon lift its share price and everyone benefits. An MF scheme is devoid of sentiments as it is a pass-through vehicle.” To that extent, he adds, when Fidelity AMC issued bonus units (two units for every 500 units held) in May 2010 soon after it completed five years were “true bonus units”, as Fidelity AMC paid them out of its own capital. The NAV of Fidelity Equity Fund (to whose unitholders the bonus units were paid) did not come down after the bonus units were distributed.
Mint Money take
Avoid being swayed by the lure of fund houses declaring bonus units. Fortunately, not many fund houses declare bonus units anymore. But make sure you invest in a scheme that comes with a good track record, rather than one that gives bonus regularly.
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First Published: Mon, May 02 2011. 09 10 PM IST
More Topics: Bonus | Mutual Funds | Dividends | Tax | UTI |