Mutual funds that still enjoy indexation benefit

Ever since debt funds, international funds and gold funds lost indexation benefits - an inflation-adjusting feature that lowers tax liability - investors, especially conservative ones, have been in the dark about what to do now.

Krishnan V, one of our subscribers, is among them. He contacted us, asking if there's a mutual fund with a 40-60 equity-debt split that also offers indexation benefits.

We hope the below table answers the question.

As you can see, balanced hybrid, multi-asset and dynamic asset allocation funds still retain indexation benefits. Let's look at them at a glance.

Balanced hybrid funds
The equity allocation in these funds usually fluctuates between 40 and 60 per cent, activating indexation perks.

That said, there are no balanced hybrid funds currently in the market. Instead, what you have are a few solution-oriented funds. A few examples of these funds are UTI's children's career savings funds and retirement benefit pension funds.

Multi-asset funds
These funds invest in at least three asset classes, with a minimum allocation of 10 per cent in each.

The asset classes include equities, debt, real estate, international securities and commodities like gold and silver.

However, the equity allocation in these funds can vary widely, and the indexation benefit depends on this equity allocation. The fund receives indexation benefits only if the equity allocation lies within the 35 per cent to 65 per cent range.

So, keep a close eye on the fund's asset allocation to ensure it qualifies for the indexation benefit.

Moreover, these fund's decision to invest in commodities and real estate do not sit well with us. We have, for long, believed that they are not great investments in the long run.

Dynamic asset allocation (AKA balanced advantage funds)
Technically speaking, these funds can choose to have a 35 to 65 per cent allocation in equities and the remaining in debt. That said, quite a few of them have a higher equity allocation, thereby limiting the choice of conservative investors and retirees.

What got us thinking now is whether it makes sense to do a 40-60 equity-debt allocation yourself.

There are two reasons why:

• There are very few mutual funds in the 40-60 equity-debt space.
• We also wanted to see if the do-it-yourself (DIY) method is tax efficient.

So, we pitted UTI Children's Career Fund - Savings Plan with a DIY allocation, and here's what we found:

Although the DIY asset allocation option has a marginally higher tax liability, its post-tax returns are considerably higher, as shown in the above table.

There are two reasons why:

• The DIY investment (40 per cent in a flexi-cap fund and the remaining 60 per cent in a short-duration debt fund) generated 9.2 per cent as against the UTI fund's 8.35 per cent
• The DIY tax liability was not too high compared to the UTI fund because flexi-cap fund gains up to Rs 1 lakh are exempt from tax.

The last word
Clearly, the DIY route makes more sense for retirees or conservative investors looking at a 40 per cent exposure to equities.

However, don't dive into it headlong. Opt for the DIY option only if you have the knowledge and time to monitor and adjust your portfolio.

Suggested watch: Debt funds lose favourable tax treatment. What now?