There is a need to educate investors in Nepal about the importance and significance of mutual funds.

--BY SUSHIL MAHARJAN

The implementation of the new Merchant Banker Regulation 2074 BS, which was approved by the Government of Nepal, was made possible by an amendment to the Merchant Banking Regulation 2064 BS by the Securities Board of Nepal (SEBON). This has been good news for merchant bankers looking to broaden their operations and expand their services. This is indeed a very promising development for the capital market in Nepal; it definitely has opened access to the market for small, medium and high net-worth individual investors. We have already seen some prominent mutual fund subsidiaries of commercial banks like NIBL Capital, Siddhartha Capital, NMB Capital etc along with many other companies which have successfully launched various mutual fund schemes in the market.

Many know what a mutual fund is, but for those who don't know a mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities such as stocks, bonds and money-market instruments. For instance, NIBL Capital has a professionally managed investment fund which pools money from investors to purchase securities. NIBL Capital will launch various schemes under which units are sold to raise capital. Investors will purchase units in the mutual fund if interested. When you invest in a mutual fund, your money is pooled with the money of other investors and invested on your behalf by the NIBL fund manager.  The biggest advantage mutual funds have is that your invested money will be managed by a professional fund manager (instead of yourself) and are ideal for anyone who wants to invest in the long-term, typically 5 to 10 years. Depending on the fund’s structure, some mutual fund schemes provide monthly, quarterly, semi-annual or yearly distributions. Mutual fund investors need to carefully check the fees and expenses of mutual fund schemes, as even small differences in fees can translate into large ones that can affect investment returns over time.  The top three costs are sales charges paid by the investor, management fees and operating expenses (with the last two making up the Management Expense Ratio or MER) paid by the fund; this also includes trailing commissions. 

You can find information about fees in a mutual fund’s fact sheet and in its simplified prospectus. Which schemes suit you as an investor? First of all, know your desire for risk, as this determines the asset allocation and the type of funds that fit your investment profile. If market volatility does not bother you and your investment timeline is more than 5-10 years, it is best to select portfolio schemes that are entirely equity funds with a small to mid-cap orientation; these can give spectacular returns but can also carry high risks. We know that Nepal is one of the least developed countries in the world, hence it has to make different strategies and plans for the professional collection and mobilisation of the country’s available capital; mutual funds can play a vital role in that.

In the current scenario of the Nepal capital market, there are already14 mutual fund schemes available, with a total value of approximately Rs 14.40 billion. These mutual funds are closed-end, which requires a broker to buy and sell.  Although mutual funds are becoming popular every day, investors have to understand market volatility before investing. As of 2015, less than 10 percent of households in India invested in mutual funds despite their availability in the market; compare that to Canada, where 4.9 million households or 33 percent of the population held mutual funds.

It is a magnificent opportunity to invest in Nepali mutual funds, not only because of the potential risk-to-reward ratio but also because of the government’s preferable tax treatment to mutual funds. The waiving of taxes on capital gains and interest income has enabled the growth of the mutual fund industry in Nepal. A mandatory provision to allocate 5 percent of total Initial Public Offerings for mutual funds will also be helpful. As per the Securities Act of Nepal, SEBON registers mutual funds, grants permission to those who wish to operate them and finally, it oversees and monitors the operations of the Nepali mutual fund industry. 

Another benefit of investing in mutual funds is that they are listed on the Nepal Stock Exchange, so they are easily traded, thus providing liquidity. The only problem with mutual funds in the Nepali context is that an investor can hardly get neutral analysis of the funds from the sponsoring banks, though there exist numerous mutual fund schemes. Otherwise, mutual fund investors will not have to pay any corporate taxes associated with the shares held within a mutual fund portfolio and also are exempt from paying any taxes on dividends received on shares and debentures. Neither do they have to pay taxes on any interest received on deposits at financial institutions. This will be important for the continuing development of the Nepali mutual fund industry, even though the capital gains tax and dividend tax will be the same at 5 percent each. On the other hand, mutual fund managers will see increases in their total portfolio holdings and assets under management, or AUM in short.

Now let's consider the international tax treatment of mutual funds taking the example of Canada first. When an investor sells mutual fund units, the investor may have a capital gain or loss. Generally, 50 percent of that capital gain is taxable in Canada. In the US, mutual funds are taxed differently; short-term capital gains, especially on stock funds, are taxed as regular income while long-term capital gains are taxed at no more than a flat 15 percent to 20 percent. For tax purposes, short-term capital gains are for less than one year, and long-term applies to assets held longer than one year. The maximum rate is 20 percent. Otherwise an investor pays 15 percent or zero. In neighbouring India, short-term capital gains from equity mutual funds are taxed at 15 percent, while those of debt mutual funds are taxed as per the investor’s own income tax rate. Long-term capital gains from equity funds are not taxed. However, debt funds are taxed at 20 percent with an indexation benefit. As per India’s recent Finance Bill 2018, there are two major changes to equity mutual funds: a 10 percent tax on long-term capital gain from them and a 10 percent dividend tax. These are encouraging signs for the Indian mutual fund industry and investors.

SEBON and the Ministry of Finance are already in talks to cut taxes on share trading in an attempt to boost the stock market, which will also see mutual funds benefit. So, by and large, investors should not hesitate to invest in this incredible period in Nepal’s mutual fund history.  Investors should and must consult with a professional portfolio management advisor on their own particular circumstances when making investment decisions, as each mutual fund has a different objective. Some may invest for capital growth, which means that increasing the value of your investments over the long-term is important. Others may be income investors, which means that earning a steady income from your holdings with the lowest risk possible is a priority. The advisor will help investors who lack the time and the skills to manage their investments and inform them of any possible tax benefits. 

The author is Deputy CEO of Civil Capital Market Ltd. He has an extensive experience in the financial services industry. Earlier he was with CIBC Mellon, Canada