Critical issues in the mutual fund industry needs to be resolved

The task force for capital market reform recently submitted important recommendations for the mutual fund industry.

Among their recommendations is the proposal to discontinue closed-end mutual funds after their 10-year tenure. The taskforce also advocated for the recognition of various existing mutual fund types – such as equity, growth, balanced, fixed income, and Shariah-compliant funds – along with defined investment allocation criteria. If implemented, these measures could surely enhance the industry's prospects.  

However, further considerations are necessary to enhance the long-term sustainability of Bangladesh's mutual fund sector. Here is why.  

Limited discretion of asset managers

According to the rules, at least 60% of a fund's portfolio must remain invested in capital markets at all times. This regulation is detrimental as it restricts the fund manager from capitalising on available unrealised gains by allowing them to realise those gains before an anticipated market downturn. It hinders investors from mitigating potential losses, as they are unable to exit from their existing positions in an anticipated downturn. It also prevents investors from seizing opportunities for future returns, as the inability to liquidate positions and remaining in cash during a market upswing limits their capacity to reinvest at more attractive valuation levels during the downturn.
This arbitrary provision may lead investors to favour direct equity investment over mutual fund investment, as the former offers the flexibility to liquidate positions and retain cash holdings in anticipation of a market downturn, thereby preserving the value of their investments.
Asset managers should be granted greater discretion in asset allocation to optimise risk-adjusted returns. The minimum investment threshold should be reconsidered to enable timely market exits and re-entries.

Unequal tax treatment of mutual funds

Currently, only investments in listed securities qualify for tax rebates, excluding open-ended mutual funds. This policy discourages investment in professionally managed funds and incentivises direct equity market participation, exposing retail investors to heightened risks. This is unfair due to the following reasons:  

The investment criteria for closed-end and open-ended mutual funds are identical under current regulations, warranting equal tax benefits. Since both fund types share similar portfolios, extending tax rebates to open-ended funds ensures fairness.  

Open-ended funds provide liquidity at net asset value, whereas closed-end funds often face market price distortions. Given their stability, policy should incentivise investment in open-ended funds.  

The tax rebate should extend to open-ended mutual funds, given their similar investment characteristics to closed-end funds. The Bangladesh Securities and Exchange Commission (BSEC) must engage with the National Board of Revenue (NBR) to rectify this imbalance.

Capital gains tax disparity

In November, the NBR brought a change in the treatment of capital gains tax, where reduced capital gains tax rates were applied exclusively to listed securities, removing the earlier preferential treatment for mutual funds in general. This policy diminishes the appeal of mutual funds relative to direct equity investments, leading to higher exposure to market volatility. A mutual fund is a diversified investment vehicle, investing in listed securities as well. Thus, investors should receive equal tax treatment whether investing through a mutual fund or directly in the equity market.  

Tax policies should be adjusted to ensure parity between direct equity investments and mutual funds. Mutual funds should benefit from lower capital gains tax rates, encouraging structured, professional fund management.

Mandatory dividend distribution for mutual funds

Mutual fund rules require mutual funds to distribute at least 70% of earnings (50% for growth funds) as dividends annually. However, this is inefficient and unnecessary for the following reasons:  

Open-ended mutual funds allow investors to redeem units at Net Asset Value (NAV) anytime, reducing the need for mandatory dividends.  

Since dividends are deducted from NAV, they do not impact the overall returns of the investors. Investors can always create their own dividend by redeeming units as needed at any point in time.  

This requirement adds operational complexity and costs, ultimately lowering investor returns.  

Additionally, many investors exit before the record date to avoid dividends, forcing asset managers to hold excess cash, limiting long-term investments, and disrupting compounding, thereby reducing return potential.  

It is important to note that there are no minimum dividend disbursement requirements for mutual funds in India, Pakistan, and Sri Lanka.  

Dividend distribution policies should be reassessed, delegating such decisions to fund trustees based on investor preferences. This would enhance fund efficiency, reduce administrative costs, and align practices with international markets.

Stamp duty on mutual fund registration

The Finance Act of 2022 introduced a 0.1% stamp duty on mutual fund registration, reversing prior exemptions. This increase imposes an unnecessary financial burden on the industry, deterring fund launches.
A mutual fund with an initial target size of Tk25 crore, but launched by meeting the 40% minimum requirement (Tk10 crore), would effectively incur a stamp duty of 0.25% (0.1% of Tk25 crore = Tk250,000, which is equivalent to 0.25% of Tk10 crore) during the registration phase. This levy represents a considerable burden that could adversely affect the operational viability and performance of mutual funds.
The BSEC should advocate for reinstating exemptions for mutual funds, ensuring the industry's continued growth and market stability, considering that the Bangladesh mutual fund industry is still in the developmental stage.

Restricted mutual fund distribution channels

Bangladesh's mutual funds lack widespread distribution, unlike National Savings Certificates (NSCs), which benefit from the extensive bank networks in the country. Additionally, we have seen initiatives such as 'Bancassurance'—a collaboration between banks and insurance companies—encouraged by the World Bank, which aims to popularise insurance products by leveraging banking networks. These examples demonstrate the potential for mutual funds to foster greater collaboration within the broader financial sector, especially banking networks in the country.
Mutual funds should be integrated with banks and mobile financial services (MFS) to enhance investor access at the retail level and industry penetration, similar to successful practices observed in India.

Misclassification of sector categories

Marico Bangladesh Limited, despite operating in the Fast-Moving Consumer Goods (FMCG) sector, is classified under 'Pharmaceuticals & Chemicals' on the stock exchanges. This misclassification restricts institutional investments due to sectoral exposure limits imposed by regulators, i.e., BSEC and Bangladesh Bank.
Sector classifications should be revised to reflect economic realities and the nature of businesses, allowing for more accurate investment allocation and enhancing market efficiency. Given the nature of Marico's operations, it would be more appropriate to classify the company under a newly established 'Consumer Care' or 'FMCG' sector rather than the existing 'Pharmaceuticals & Chemicals' category.
Reforming Bangladesh's mutual fund and asset management industry is critical for ensuring a more stable and diversified capital market. Regulatory adjustments, enhanced tax incentives, and broader distribution channels are essential to unlocking the sector's full potential. A collaborative effort between BSEC, NBR, and financial institutions can drive the industry toward sustainable growth and enhance investor confidence.

Writer is the Chief Operating Officer at Midland Bank Asset Management Company Limited