When the Government of India divested its stake in key state-owned firms in May 2014 through Central Public Sector Enterprises (CPSE) Exchange-traded Fund (ETF) and later again through Bharat 22 (B22) ETF in November 2017 (apart from the two follow-on offers of CPSE ETF in early 2017), they provided a good opportunity to investors to own stakes in large government-controlled monopolies, plus three large private sector companies. But it wasn’t that easy. Since these are ETFs and listed on the stock exchanges, you needed a demat account to buy them. Budget 2018 has proposed to remedy this.
An annexure to finance minister Arun Jaitley’s Budget 2018 speech said that fund of funds that invest at least 90% of their corpus in ETFs will be accorded the status of an equity funds. Further, such ETFs must also invest at least 90% of their corpuses in underlying securities.
Note that all existing fund of funds are treated on par with debt funds, as far taxation rules are concerned. Debt funds attract a long-term capital gains tax of 20% with indexation if you sell your debt fund units after 3 years of holding them. If you sell them before 3 years, your capital gains are clubbed with the rest of your income and taxed at income tax rates.
Equity fund of funds are also taxed akin to debt funds, even though they invest their entire corpuses into equity funds.
But the Budget 2018 doesn’t seem to have developed much affection towards fund of funds by bringing in the proposal to treat them on par with equity funds. It is something else that they are after.
Instead, the government appears to have caught on the fancy of divesting its stake in state-owned companies through the ETF route.
Through CPSE ETF’s new fund offering in May 2014 and its follow-on offers in 2017, the government collected roughly Rs11,500 crore. Through the B22 ETF, the government divested shares worth Rs14,500 crore. By bringing fund of funds on par with equity funds, it wants to make the divestment ETFs more accessible to the people. And the tax status is a carrot. To invest in fund of funds, you do not need a demat account.
As per Value Research, there are six equity-oriented fund of funds existing at the moment. None of these would qualify to be equity funds under the new Budget 2018 proposal, as none of these invest in—and solely—ETFs. Also, the underlying mutual fund schemes in all these fund of funds do not invest at least 90% of their corpuses in equity shares. Many are allowed to hold cash and or debt securities up to 35%; a condition that would disqualify all the existing fund of funds. It is only an ETF that would always invest at least 90% of its corpus in equity shares at all times.
The Budget further clarifies that for a mutual fund to be considered an equity fund, the minimum threshold of equity holding of 65% continues. This shows that the government has carved a special status for such fund of funds that aim to invest in ETFs; presumably divestment ETFs. Expect fund houses to launch fund of funds that invest in such divestment ETFs in future, especially since Budget 2018 also said that more such divestment ETFs are on their way.