Mutual fund (MF) investors in the country are spoilt for choice. There are 1,500-odd MF schemes that vie for investor attention. So, after making the right choice, what happens to the MF units that you buy? Read on.
There are two ways to store your MF units— in a statement of account (SOA) with an asset management company (AMC) or a demat account with a depository participant (DP) such as the Central Depository Services Ltd (CDSL) or the National Securities Depositories Ltd (NSDL). SOA is a traditional electronic record keeping system and demat is the electronic format for holding MF units.
When you buy a mutual fund, your money is first sent to the AMC and simultaneously an order is passed to the registrar and transfer agencies (RTAs). There are only 2 RTAs currently registered with market regulator Sebi and handle record-keeping and transactions for mutual funds and equity investments. After the money is received and the details are validated by the RTAs, the units are allocated and stored in the RTA’s system using your details. This is the SOA format. In case of a demat, the RTA sends the holding details to a DP, which manages the investor’s account.
A demat account is better if you trade frequently, want to manage a diversified portfolio, or invest in exchange traded funds (ETFs). There is also less flexibility if you want to change your broker.
Fintech firms like Zerodha and Upstox store your MF units in the demat format, whereas others like Groww, Paytm Money, Kuvera, and Dhan keep it in the SOA format. To be sure, a majority of these firms use the stock broker license to sell mutual funds. This means that they require you to open a demat account regardless of the units being stored in the SOA format. Kuvera operates using the RIA license and does not require you to open a demat account.
In SOA, you can redeem the MF units by entering the exact amount (in rupees, based on the value of the unit) that you want to withdraw. In demat, investors can buy or sell only in terms of units. This becomes an issue since the value of the unit changes daily. So, if the value of 10 units is ₹10,000 today, it could rise to ₹12,000 or fall to ₹8,000 based on whether the markets go up or down on that day.
The demat format also does not support systematic transfer plan (STP) or systematic withdrawal plan (SWP). STP allows you to shift seamlessly from one mutual fund to another of the same AMC. For instance, you can shift from HDFC liquid plan to HDFC mid-cap fund without redeeming your funds. SWP allows you to withdraw money in defined intervals as opposed to SIP where you invest a particular amount every month or quarterly.
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Bhuvanesh R, business analyst at Zerodha’s Coin, India’s largest direct MF platform, said that although SWP is not inbuilt in the demat ecosystem, the company has built its own API, or application programming interface, to support this feature. However, the firm still does not have the STP feature yet. It is currently designing an API that will allow STP between schemes of different AMCs.
As for fees and charges, SOA simply scores over demat. While maintaining an SOA account is free, the demat format may involve account opening and transaction fees and even annual maintenance charges. But a demat account comes with its own advantages. You can use it to hold other assets such as bonds, shares and ETFs. While an SOA allows you to download an electronic consolidated account statement (e-CAS) of all your holdings in one place, a demat account allows you to track your assets in real time.
Easy transfer of assets is another significant feature of demat accounts—A single nomination works for the entire gamut of assets held in it. In SOA, you have to enter a nomination for each AMC. It also becomes easier to transfer units if you hold them in demat format.
Abhishek Kumar, a registered investment advisor (RIA), usually recommends the SOA route to most of his clients. However, he recalled that in one instance, one of his clients wanted to send money to his daughter and Kumar recommended the opening of a demat account. The client could use it to buy debt MFs and transfer these to his daughter. The demat route not only helps transfer MF units seamlessly but also reduces tax liability. That’s because debt MFs are taxed as per an individual tax slab rate on redemption. In the above case, Kumar’s client was in the higher income tax bracket. If he gifted the debt MF units to his daughter, the latter could redeem it at a lower tax rate. Mutual funds in SOA cannot be gifted.
Keeping mutual funds in demat also comes in handy for short-term traders. Mayank Lavania, senior product manager at Fisdom Mutual Fund, said that traders can pledge MF units and obtain a margin loan against it. This is not possible if the units are held in the SOA form. However, Kapil Nagal of Volt Money said that investors can take loan against MF units even if it’s in the SOA form.To be sure, margin loans can only be used to buy securities for the demat account.
The right platform
Choosing the right platform for your investments is important. Fintech firms currently allow you to choose from a host of MF schemes but you need to decide whether you want to hold the units in demat or the SOA format. There are other ways to invest as well. You can also invest directly using an AMC’s website (or app) which stores your units in SOA. The only drawback is that you have to create a separate account for each AMC. Another way is to use the service of the Mutual Fund Utilities (MFU) platform. MFU is a transaction platform run by all MF houses under the aegis of the association of mutual funds in India. MFU allows you to hold units in SA format.
Ravi Saraogi, a Chennai-based RIA, prefers the MF Utilities platform than fintech apps. He said fintech apps currently don’t earn any profit from selling MFs and so they lure an user with offerings like futures and options.