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With the mutual fund industry AUM crossing ₹37 trillion in May’22, mutual funds have become an extremely popular investment option in India. According to a recent survey of 5000 investors, almost 73% weren’t properly aware of the concept of dual stage dividends in MF. In this article, we cover the concept of dual stage income/dividends in all MF schemes.

The Concept of MF returns

MF schemes generate returns based on the appreciation of its constituents. Let’s say the AUM of a scheme is ₹10,000 cr and no. of outstanding units is 100 cr. NAV of the scheme at the start of the month = ₹100. Due to appreciation in the overall market, the AUM increases to ₹10,650 cr. at the end of the month. NAV of the scheme now stands at ₹106.50. The monthly return stands at 6.5%.

Distribution of MF income (returns)

The NAV appreciation of ₹6.5 can be treated in multiple ways based on the scheme memorandum:

  1. Let the return accumulate & use ₹106.50 as the base for next month (growth)
  2. Distribute part of/entire ₹6.5 to the investor as cash (monthly payout)
  3. Re-invest ₹6.5 in the scheme by buying additional units after 7.5% TDS deduction (monthly re-investment)
  4. Let the appreciation accumulate over 3/6/12 months & follow pts 2 & 3 (quarterly/semi-annual/annual payout/re-investment)

As per SEBI’s latest guidelines, all schemes need to be categorized into 2 buckets – Growth (1) & IDCW – Income Distribution cum Capital Withdrawal (2, 3 & 4) based on AMC’s treatment of Level 1 or Scheme returns.

Distribution of Constituent income (returns)

Now, we come to Level 2 or Constituent-level returns of any MF scheme. A Bluechip fund might contain few stocks which frequently pay dividends. A Corporate debt fund might have bonds which pay coupons after every 6 months. Irrespective of the Level 1 category, all schemes are subjected to Level 2 income since these are mandatory events on the fund constituents.

Now, an AMC can treat Level 2 income in multiple ways:

  1. In case of a Growth scheme:
    • Use cash from dividend/coupon to acquire more units/qty of the same security at ex-div/coupon price to maintain similar scheme composition
    • Use distributed cash to buy other undervalued securities in same category (industry/credit tranche etc.)
  2. In case of an IDCW scheme:
    • Add part of/entire distributed cash to monthly appreciation (considering price adjustments after ex-date adjustment) & distribute to investors as per Level 1 IDCW sub-categories
    • Follow above Growth scheme steps by acquiring more units/qty of existing/new scheme constituents

Dual stage returns

Thus, MF returns are a combination of Level 1 & Level 2 incomes of the scheme. In our survey, while 89% of the respondents were partially aware of Level 1 income, majority were unaware of Level 2 income with majority assuming that Growth schemes are completely independent of any type of dividends. Hope our article helped you learn about the dual stage treatment of income/returns in MF schemes.

Sayantan Ghosh<br>MBA (Finance), FMVA®
Sayantan Ghosh
MBA (Finance), FMVA®

Sayantan is a Finance enthusiast, currently working as a Hedge Fund analyst and has written more than 25 articles for various Finance blogs & websites.