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How do fund houses declare the dividend for a scheme?

LiveMint logoLiveMint 27-03-2017 Kayezad E. Adajania

Although mutual funds across all asset classes declare dividends, they are never assured. Also, the capital market regulator, Securities and Exchange Board of India (Sebi) rules state that fund houses must declare dividends out of realisable surpluses, and not just paper profits. In simpler words, if your scheme’s net asset value goes up from Rs12 to Rs12.50 purely because the share prices of some of its underlying companies went up, the fund cannot declare a dividend. Your scheme should have actually sold those shares at a profit to be able to declare dividends.

In the earlier days, fund houses used to announce upcoming dividends and then pay them much later. A lot of investors used to take this cue, invest, pocket dividends and then immediately redeem their investments after their NAVs fell—after dividends are distributed, NAVs fall. Such a move would lead to investors suffering a capital loss, which they used to then offset against other capital gains and lower their overall tax outgo.

Union Budget of 2004 plugged this loophole and said that anyone who buys mutual fund units within 3 months before the record date and sells them within 9 months after the record date, cannot claim the capital loss that arises out of NAV reduction caused by dividend declaration. In 2006, Sebi ruled that the record date should be 5 days after the day on which the announcement declaring dividend is made so that not much time is given to those who invest in mutual funds just to pocket a loss. So, if your fund declared dividend on 1 March, then the record date of dividend should be 6 March. Record date is the date on which a fund house determines who are the investors. Also, once a fund house’s trustees approve the dividend declaration, it has to announce it within one calendar day.

There are components of a scheme’s NAV: the face value (Rs10, typically), the dividend equalization reserve (DER) and unit premium reserve (UPR). Say, the NAV goes up from Rs10 to Rs15 but the scheme cannot pay entire Rs5 as dividends, it has to sell shares and book profits. Say, it books Rs2 as profit. This goes to the DER and the balance (Rs3) goes into the UPR.

Here’s what is interesting. Out of the Rs2 that goes into DER, the scheme may not necessarily distribute everything. It could save some for a rainy day. Like when markets are on a continuous fall and it could not book any profits. It can then dip into the existing DER profits, which were previously booked but yet not distributed, and then distribute that. That’s why old (about 20 years or even older) and large-sized equity schemes declare dividends at regular frequency, to give their investors some kind of comfort or expectation as to when a dividend might come their way.

Once your fund house sends you a dividend receipt (provided your email ID is on its records), check your bank statement to see if you have got the credit. Also, your fund house will send you a monthly common account statement in the month after the one when your dividend was declared. It’s good to keep a check.

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