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Debt-Oriented Mutual Funds

30 Jun 2025 GS 3 Economy

Background: Changes in Taxation 

  • Earlier: Debt Mutual Funds (MFs) held for over 3 years attracted Long-Term Capital Gains (LTCG) tax with indexation benefits, reducing tax burden significantly.

  • Since April 1, 2023: All fresh investments in debt MFs are treated as Short-Term Capital Gains (STCG) and taxed at the investor’s marginal slab rate (typically 30% + surcharge and cess).

  • Income Distribution cum Capital Withdrawal (IDCW) option (earlier dividend) is also taxed at marginal slab rate.

  • Budget 2024 Changes (Effective July 23, 2024):

    • Fund of Funds (FoFs) and Multi Asset Funds are now taxed at 12.5% (plus surcharge & cess) if held for more than 2 years.

    • Indexation benefit has been withdrawn.

Fund of Funds (FoFs)

  • Structure: Typically ~60% in debt funds, ~40% in arbitrage funds.

  • Taxation: Flat 12.5% + surcharge & cess (after 2-year holding), better than marginal slab rate for high-income investors.

  • Nature: Though not pure debt, risk-return profile resembles debt funds, making it viable for stable portfolio segments.

  • Drawback: Two expense layers:

    1. Expense ratio of the FoF itself

    2. Expense ratio of the underlying funds

Expense Ratio is the annual fee that mutual funds charge investors to manage their money.It is expressed as a percentage of the total assets of the fund.

Expense Ratio = Fund’s total annual operating expenses ÷ Average assets under management (AUM)

It includes costs like:

  1. Fund manager's salary
  2. Administrative expenses
  3. Distribution and marketing costs
  4. Custodian fees

Despite this, net returns are beneficial due to lower tax incidence.

Arbitrage Funds

What Are Arbitrage Funds?

Arbitrage Funds are a type of mutual fund that earn profits by taking advantage of price differences for the same stock in different markets (cash and futures).

  • Classification: Equity Mutual Funds.

  • Strategy: Profit from price spread between spot and futures segments; no directional equity risk.

  • Portfolio Composition:

    • 65–75% in cash-futures arbitrage

    • Balance in money market instruments

  • Taxation:

    • LTCG at 12.5% (if held for more than 1 year)

    • STCG at 20% (if held for less than 1 year)

  • Positioning: These are quasi-debt, suitable for fixed-income allocation with added tax benefits.

Multi Asset Funds

  • Structure:

    • Equity: 35–65% (e.g., 50–60%)

    • Debt instruments

    • Commodities: 10–15% (like gold/silver)

  • Taxation (Post July 2024):

    • LTCG at 12.5% (after 2 years)

    • No indexation benefit

  • Strategic Value:

    • If equity component is largely arbitrage-based → quasi-debt.

    • Otherwise, can be counted towards overall equity allocation.

  • Flexibility: Investors may treat the equity portion as part of equity portfolio, debt as part of fixed income.

Gold & Silver ETFs (Exchange Traded Funds)

  • Nature: Traded like equity shares on stock exchanges.

  • Requirements: Demat & trading account.

  • Taxation:

    • 12.5% + surcharge & cess on LTCG (holding >1 year)

Implications for Investors

  • Portfolio Allocation should be based on:

    • Risk-return profile

    • Investment horizon

    • Liquidity needs

  • Tax Efficiency is not the primary driver, but can improve post-tax returns within the debt allocation.

  • Investors in higher tax slabs can reduce tax burden by opting for:

    • Debt-oriented FoFs

    • Arbitrage funds

    • Multi-asset funds

    • Gold ETFs




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