Home / Opinion / Dividend stripping: running after short-term gains

Last year, eyebrows were raised when a very small sized fund house gathered slightly over 5,000 crore in a single month (July), in a single scheme. Mint reported how an informally communicated bonus payout three months before the record date, combined with the change in taxation of debt funds, was the main reason behind such a large collection. Those investors who have advance knowledge of the payout can take advantage through what’s called bonus stripping. It refers to the practice of buying units of a mutual fund with the purpose of participating in a bonus issue, which allows them to book losses on the original value invested and then subsequently set it off against gains from other sources. One has to invest in the scheme at least three months before the record date of the bonus.

A practice similar to bonus stripping is done with dividend payouts and is referred to as dividend stripping. It’s frowned upon by the market regulator, which has expressly prescribed that a dividend announcement should be made not sooner than five days prior to the record date.

For the scheme mentioned above, although the bonus payout didn’t happen in the end of October (2014) as expected, in November-end and December, bonus was paid in two tranches, which reduced the net asset value (NAV) of the bonus plan from 18.85 to 10.19 as anticipated. During December, the scheme saw a large redemption and assets were down more than 2,600 crore, or 46%. Large inflows and outflows, combined with the timing of the bonus payout, make the case very suspect and all but point to planned bonus stripping.

The raised eyebrows at the large collection in July resulted in media coverage and some informal emails within the industry denouncing such practices, which go against the spirit of the mutual fund industry itself. But, so far, nothing has changed; other than the fact that dividend stripping has now become prevalent with equity funds rather than debt funds, which was the case prior to change in taxation norms.

In December, the unofficial grapevine was buzzing with talks of a dividend stripping option being marketed to select large investors through an equity fund of a south India-based medium-sized fund house. It was done on the quiet with just two distribution partners—one of these is among the largest domestic wealth management set-ups and the other is a large domestic bank-sponsored wealth management set-up. The fund in question saw assets increase nearly four times to around 650 crore within a month.

In another case in September last year, assets under management (AUM) of an equity fund of a very small asset manager, jumped more than 12 times to around 750 crore, and 3 months later, the scheme announced a 70% dividend for its regular dividend option.

Here’s what happens. When money is collected based on advance information of a dividend or a bonus payout, often ‘chunky’ money, which is at least 2-3 times the scheme’s original AUM, comes into the fund. After the event—the dividend or bonus declaration—some of this ‘chunk’ exits the fund as their objective is achieved. And there are some more exits in the next few months, and so on.

Asset managers who indulge in such practices do so mainly for the additional AUM that comes to the table. That amount makes the fund hefty. Performance is also in focus thanks to the additional money, and then this bulked up fund is showcased to garner more assets from unsuspecting investors.

What’s even worse is the ‘stripping’ of the NAV, which has accumulated for many months, much before the announcement of bonus or dividends. Till a year or so back, fixed income funds of some of the largest asset managers allegedly went down this route to collect additional assets. But why do funds need to scamper for additional AUM? Well, apparently even a 1-2% addition to assets is worthwhile if it helps you stay ahead in the race.

But isn’t it the wrong race to be in? What about a race to increase the penetration of growth assets in this vastly populated, yet under-invested country? Why does the industry bend over to provide solutions for a handful of investors, when there are many others, albeit with small ticket sizes, who are ill informed about the right solution to make their savings work hard?

In all fairness, there is nothing wrong with bonus stripping; it is a legitimate route to book losses. Many, in fact, used the recent bonus issue announced by Infosys Ltd to do just this. But what stinks is the practice of selective disclosure; this is a poor reflection of the spirit of an industry that does a lot of good through effective money management for scores of genuine investors.

Some wealth managers I spoke to said they would go ahead with a bonus or dividend stripping option presented to them if their client needed it, but they won’t go looking actively for it. The larger point, however, is that such options exist; they are regular; and they are offered by more than just one or two asset managers.

When a fund gets bulky inflows, returns for existing investors get diluted as it takes time to deploy the money and large amounts aren’t always quickly invested in the most efficient options. Some may argue that the corpus of such funds was too small to begin with to have a meaningful lot of existing investors. But can we ignore that the fund manager’s investment decisions aren’t dictated by the best investment choice rather more by the time period for which the funds are likely to stay on? That’s not asset management, that’s AUM management.

It’s high time that all asset managers get serious about money management and set sights on the long-term benefits that mutual funds offer. The industry, over the past 20 years, has proven the benefits it can bring to the table. To be sure, dividend or bonus stripping is something that only a handful of asset managers indulge in; nevertheless, unethical fringe practices only make the case stronger for the non-believer (in the benefits of mutual funds). It is not a practice to be proud of.

Hopefully, the indulgent will rethink their strategy to shore up assets in the short term and take advantage of this expected multi-year equity rally, which we may be in the midst of, to garner long-term stable equity assets from investors who indeed need such solutions. For the regulator, just expressing concern isn’t enough; a firm hand is needed to control such practices.

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