Mutual Fund Transferability – Gifting & Transferring of Mutual Funds

Mutual Fund Transferability – Gifting & Transferring of Mutual Funds
Many people intend to gift Mutual Fund units to their closed ones as a token of love or even bequeath it to their loved ones after demise. However, there are certain complexities involved in this transfer process.

What are the benefits of Mutual Funds?
Investing in Mutual Funds is considered one of the best investment decisions for an ordinary investor looking to book capital gains in future. Also, since they have a long-term horizon of 5-15 years with guaranteed financial security, mutual fund transferability is a necessary process. We shall explore the feasibility & technicalities associated with gifting or transferring mutual funds to another owner.

Transfer or Transmission :
Units of a Mutual Fund are transferred to a surviving member in case of an untimely demise of the first holder, it is known as ‘transmission’ of Mutual Funds. On the other hand, a ‘transfer’ is said to happen when all the unit holders are alive.

a) Transfer of mutual funds is a grey area since as per the SEBI regulations, 1996, transfer of Mutual Fund units is allowed. However, the fund houses don’t let all the unit holders to transfer their units, en masse. The argument presented by them is that since these Mutual Fund units could be quickly sold & liquidated, there is ‘no point’ transferring funds.

b) Transfer of mutual fund units from one holder to another is quite rare. So the concept of gifting mutual fund units also is a hypothetical one &is practically not possible.

In fact, ‘third party’ payments are not accepted by mutual funds. In no way can one use his/her spouse’s money to invest in their name or vice versa. This might seem devious, but this is the only process one needs to follow in case one wishes to transfer mutual fund units. So if you want units to be in a relative’s name, then you need to transfer money first to the receiver’s account. You will then be able to use that amount to invest in the fund by their name.

The only scenario in which mutual fund units can be transferred to another is in case of the demise of the unit holder. This is usually in favour of a joint holder or a legal nominee to whom the transmission of a mutual fund unit takes place.

What are the legal documents needed?
In case of a nominee staking a claim to investment, the fund house asks for a set of legal documents.

1. Death Certificate of the Deceased. 
2. Letter from Co-Holder/Nominee.
3. KYC of the Nominee. 
4. Mandate to register the nominee's bank account. 
5. Indemnity bond if the amount exceeds 1 Lakhs.

As per SEBI’s circular, one would need a letter from a joint holder or a nominee (in case there is no joint holder). Also, the death certificate of the deceased unitholder, the Know-your-client documents of the nominee will be required. One would also need the bank account mandate to get nominee’s bank account registered, instead of the one that is already existent or the one belonging to the deceased unitholder. These documents might range from an indemnity bond if the invested amount exceeds Rs.1 lakh to an affidavit by the legal heir.

Starting a SIP for a Minor :
If you are looking at mutual funds to create a fund for your child, then it’s better that you start when they are a minor. You can buy MF units in your child’s name & choose the SIP scheme. The payments will be made into the account until your child reaches majority. The minor, i.e. your child, would be the first & the sole holder of the account & no joint holders are permitted under this scheme. You will act as a guardian until your kid reaches 18 years of age.

The AMC will send across a document before the date on which your child attains maturity. The document will act as a de facto application for changing the account for ‘minor’ to ‘major’ status. The guardian will not be allowed to operate the account anymore. Some other documentation like KYC, etc. will also be required for the process to be complete. Your child will then be able to reap the benefits of the MF investments you have made on their behalf.

SWP for Senior Citizens :
Our parents have looked after us all their lives. If you wish to do something beautiful for them, then look no further than investing in MF schemes with a monthly interest payment facility. Along with Rupee Cost Averaging, the SWP schemes also provide you with tax benefits as the prime investors.

Plus, it will give a fixed sum to your parents to help them meet their needs. So, instead of waiting for a transfer or transmission of your MF units, why not invest in a SIP/SWP scheme for your children or your parents which will be more effective in the long run?

Nine things you need to know before investing in Index Mutual Funds, ETFs

Nine things you need to know before investing in Index Mutual Funds, ETFs
While investing in passive funds, investors' decisions should not be driven by just expense ratio of the fund.

Key Highlights :

• Passive funds are not always safer
• Passive funds also underperform the index
• Tracking error & tracking difference in passive funds are not the same

Of late, more & more retail investors are getting attracted towards passive mutual fund schemes as actively managed funds have failed to outperform their benchmark over the last couple of years.
Looking at the investors' interest fund houses are lining up new ultra-low-cost index fund offerings. A few weeks back, Navi Mutual Fund created a buzz with its first offering—a Nifty50 index fund, which has an expense ratio of only 0.06%.
Index funds simply try to mirror the performance of their underlying index by holding the same stocks in the same proportion in which the index holds.
Despite this, index most funds fail to match the performance of the index they track.
Passive funds also have some drawbacks & advantages as well which investors should know before investing. 

Here are nine things investors should know about Index Funds & ETFs.
1. Passive funds are not always safer
Many investors are of the opinion that index funds or ETFs are safer than actively managed funds. Worth mentioning here is that both active funds and passive funds invest in equities, which by nature are volatile. So if the market falls index funds will also fall in line with the index. However, as index funds track a particular index, the quantum of fall may be lesser than active funds in general. But both active and passive funds carry market risk and can fall if overall markets fall. But the only difference in case of index funds is that their risk profile is consistent with the underlying index.

2. Passive funds also underperform the index
Although index funds try to mirror the performance of an underlying index, in most cases they underperform their benchmark. Returns of a passive fund are usually slightly lesser than the index it tracks, for multiple reasons. “The index itself is a theoretical concept and replicating it comes at a cost.” Worth mentioning here is that a fund's NAV is arrived at after deducting expenses. So more the expense ratio of a passive fund, the more will be underperformance. The cash position held by the fund also contributes to the gap in performance. Also, inflows & outflows in the fund lead to divergences in performance. This apart, tracking difference may also arise during rebalancing.

3. A passive fund can also outperform its Index
Sometimes, passive funds outperform their underlying index due to several reasons. Index funds having higher cash positions tend to outperform their index in case of market corrections. But if your fund is consistently outperforming its index—showing positive tracking difference then it is a matter of concern as it implies the fund manager is either struggling to mirror the changes in index or may even be taking unwarranted risk on the index portfolio. Experts say in a normal scenario, index funds are expected to show a nominal negative tracking error.

4. Tracking error & tracking difference are not the same
Most investors believe that tracking error & tracking difference of an index fund are the same. Typically investors use these two words interchangeably but these two are not the same. While tracking difference indicates the difference in return between an index fund & its benchmark index, tracking error signifies the volatility in the performance of the index fund relative to its index. tracking error is calculated by annualising the standard deviation of the tracking difference of an index fund. Tracking error captures the consistency in the fund’s tracking difference over a period of time. A high tracking error shows that the fund returns relative to its index keep varying widely & it is not a good sign.

5. Lowest expense ratio does not guarantee better returns
Typically investors tend to invest in the index fund that has the lowest expense ratio. But that does not guarantee better performance or lower tracking error. “Many other factors can still create a divergence between the fund & its index.” Funds with high expense ratios can also track the index better & funds with low expense ratio may clock high tracking differences. Obsessing over lowest cost index funds will be no different than yearning for highest return active funds. It traps you in the same endless pursuit. Just pick a fund with a reasonably low cost & stick with it for your investing time horizon, the publication mentioned.

6. There are additional costs in ETF other than expense ratio
Expense ratios of ETFs are even lower than index funds. But that does not mean that investors are better of buying ETFs. Unlike index funds, ETFs can be bought & sold on exchanges from other unitholders. So investors have to pay brokerage along with taxes & depository charges hide buying & selling ETF units from the market. These expenses increase the overall cost of holding ETFs.
Also, barring a few, trading volumes of most ETFs are very poor. This lack of liquidity often creates wide divergences between the fund NAV & the price at which it can be bought or sold. What you save in expense ratio is more than nullified by this impact cost. This gap is over & above the tracking difference common to both index funds & ETF's.

7. Watch out for creeping expenses
At present, expense ratio of passive funds are low as they aim to attract more investors. But there could be a surprise later when asset management companies achieve their target AUM. Passive funds are currently in their infancy & are inviting more assets by keeping costs very low. Recently, several index funds hiked their expense ratios. Tata Sensex Index Fund’s expense ratio increased 16 times from 0.05% to 0.8% in early April. HDFC Nifty & HDFC Sensex index funds now cost twice as much – from 0.1% to 0.2%. Similarly, UTI Nifty Index fund will charge a TER of 0.18% compared to 0.1% earlier. All these hikes were on direct plan variant, the regular plans already charge higher.

8. Bigger index doesn’t lead to greater diversification
Typically investors invest in passive funds that track a broader index such as Nifty 500 index to get the benefit of diversification. However, in real sense, this does not lead to greater diversification. Studies have shown that there is no incremental gain—in the form of lower risk—from diversifying beyond a point. In the same way, buying a broader index is not much different than buying a frontline index like Nifty50.
If you buy Nifty 100 index, theoretically, you do get 50 additional stocks but here the top 50 stocks enjoy a disproportionate allocation (84%) & the rest 50 stocks get lower allocation. So you don't get the desired benefit of diversification. The equal-weighted index will allow for more diversification in the true sense.
Similarly, if you are investing in a passive fund that tracks Nifty 500 index, large-cap stocks, account for a whopping 77% of the index, mid-cap stocks constitute 16%, while small-cap stocks make up the remaining 7%. Index funds based on broad market indices like Nifty 500 may not actually offer the diversification that investors are looking for as these indices are top-heavy.

9. Funds tracking beyond frontline indices don’t track well
Of late many fund houses have launched passive funds tracking small cap & multi cap indices. But tapping the broader market with an index fund or ETF can come at a steep cost, the publication mentioned. It may be noted that the tracking difference get bigger for broader index-based funds.
Over the past year, the gap remains up to 1% for bulk of the Nifty 50-based funds. It rises to 1.5% & beyond for the Next 50 index variants. The return differential increases to 2% for the Nifty 500 index & widens further for funds that are based on mid-cap & small-cap indices.
The main reason for this is the poor liquidity in the broader market. The low liquidity increases the impact cost, or the cost of executing a transaction.

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