Dividend stripping hasn’t abated just yet

MUMBAI: Investors in Birla Index Fund seem to have resorted to massive dividend stripping.

The scheme’s dividend option has seen its assets under management (AUM) erode by a full Rs 775 crore between the last day of February and the last day of March 2007.

Data from the Association of Mutual Funds in India indicate that the outflows happened in the latter part of the month.

The average AUM for the dividend option of the scheme in March stood at Rs 767.1 crore. This is very high compared with the AUM on the last day of the month (Rs 102.97 crore).

It clearly suggests withdrawals happened soon after March 23, 2007, the record date for the scheme’s 65% dividend — investors seem to have known well in advance of the impending dividend, sources said.

As of end-November 2006, the scheme had managed a paltry Rs 15.75 crore in its dividend option plan. The AUM suddenly spurted to Rs 942.61 crore by the end of December.

This is significant, considering one needs to be invested in a scheme for three months prior to the record date or nine months after the record date in order to be eligible to claim capital losses by selling its units after it declares a dividend.

Investors seem to have chosen the former, surely having been informed in December 2006 of a dividend coming in three months.

A look at the movement of the scheme’s AUM under the growth option further buttresses the claim that it was the upcoming dividend which caught investors’ fancy in December 2006. It remained stagnant between November and December, at around Rs 2.16 crore.

According to the Securities and Exchange Board of India Sebi), the record date now has to be just five calendar days from the date when notice on the dividend declaration is given.

A Sebi circular dated April 4, 2006 also makes it clear that "before the issue of such notice, no communication indicating the probable date of dividend declaration in any manner, whatsoever, may be issued by any mutual fund or distributors of its products."

While following the Sebi guidelines in letter, Birla Sun Life Mutual Fund seems to have neglected it completely in spirit. With official channels of communication remaining closed, the fund house seems to have kept unofficial channels wide open.

Distributors, however, say Birla Sun Life isn't alone in facilitating dividend stripping. "Other fund houses have also been doing it, though more discretely," said a distributor.

Officials at Birla Sun Life Mutual Fund were unavailable for comment despite repeated attempts over the past couple of days. An email sent from DNA Money went unanswered too.

Dividend stripping is a practice investors resort to in order to book capital losses and hence lower tax incidence, by selling out of a fund immediately after it declares a dividend. Let's say an investor had got into this scheme on December 20, 2006, a little over three months before the dividend was declared. On this day the purchase price of a unit of the dividend option of this scheme stood at Rs 21.466. Soon after the record date of dividend on March 23, 2007, the net asset value of a mutual fund unit fell to the extent of dividend.

Let's say the investor sold out on March 26, 2007, immediately after the dividend was declared. On this date the sale price of a single unit was Rs 15.039. The difference between the price at which the customer bought and sold a single unit (Rs 6.427 in this case), can be set off as a capital loss against a capital gain, thereby lowering the capital gains tax that investor will have to pay. Also, the investor manages to get a dividend of Rs 6.50 per unit, which means there hasn't been any loss in the strictest sense. The problem here for the investor was that in the interim, the markets tanked, so the gain was very limited - beyond the dividend paid.

The asset management company benefits because its management fees is a percentage of the AUM it manages. So, greater AUM means more earnings - a win-win situation for everyone.

This is not the first time Birla Sun Life Mutual Fund has used the strategy of letting investors know well in advance that it is about to declare a dividend and then getting them to invest.

DNA Money had reported on January 13, 2007, ('Dividend buzz helps sell old equity-linked savings schemes') on how the AMC had promised three dividends over a period of four months to boost investments into Birla Sun Life Tax Relief 96. Meanwhile on Monday, Birla Sun Life Mutual Fund announced the launch of the Birla Sun Life Long Term Advantage Fund - Series 1. This is a three-year closed-ended equity fund that will predominantly invest in stocks of mid- and small-cap companies. It will be benchmarked against the BSE 500 Index.