What Are The Different Kinds Of Triggers In Mutual Fund And When To Use Them

A gain cannot be called a gain until it is realised. How true is this when it comes to mutual fund investments!

Prasoon, 35, invested a considerable amount in equity mutual funds in early 2006 when the market was up. His investments almost doubled within a span of 9 months and then the global crisis hit the Indian market, crashing it like never before. Till now, Prasoon has not recovered his invested amount. He blamed his fund managers, including his advisor, for the loss.

In Prasoon's case, when the market tanked, he lost the gain he had made till then. He did not get a chance to either redeem the profit or transfer it to another fund. Had trigger facility available then, Prasoon wouldn't have lost his money.

What is trigger facility?

Trigger facility is an add-on, optional feature provided in mutual fund schemes, which enables investors to book profit automatically at a pre-defined time or value. In another words, it is an event in which the fund will declare dividend, redeem and/or switch the units automatically on behalf of the investor on the date of the happening of the event.

Are there different types of triggers available?

A plethora of choices are available to the investor when it comes to choosing a trigger. The most common of them are based on capital appreciation, date and value of NAV. The trigger point can either be an appreciation in NAV by a pre-defined percentage or an appreciation in an investment value or a specified date, etc. The various kinds of triggers available to the investor are presented in Table 1.

How it works?

Let us assume that you have invested in a trigger-activated equity mutual fund scheme at a NAV of Rs. 10 and have set the trigger at 20 per cent NAV appreciation. Once the NAV reaches Rs. 12, the trigger gets activated automatically, and your gains will be either redeemed or transferred to any of the debt schemes as decided by you. Thus, trigger provides a convenient and useful financial planning tool, especially for those who want to earn a sizeable profit within a period of time.

What are the tax issues?

Whether payout under a trigger-activated mutual fund scheme is subject to tax or not will depend on what type of trigger you have opted for.

• In case of redemption or switch, it is similar to Systematic Withdrawal Plan (SWP) where your investment units are redeemed minus exit charges, if any, and you need to pay short-term gain tax (STGT) if redeemed within one year.
• In case of 'dividend trigger', as in Tata Equity PE Fund, the fund manager announces the record date for dividend within 5 working days from the date of occurrence of trigger, i.e., when the target for NAV appreciation is achieved. Thus, investors are exempt from paying any exit load and STGT.

Pros and cons of 'trigger'

A trigger facility is a blessing, here is why:

• You do not have to track your investments all the time
• You do not have to worry about volatile market conditions as your notional gains are realised when the market moves up.

However, you need to exercise caution while selecting a trigger option, here is why:

• A trigger ceases to exist once the switch takes place.
• After booking profits at a particular trigger level, you lose an opportunity to earn gains in near future in case the market continues an upward trajectory.
• Switch carried out with the help of trigger option cannot be reversed in any condition.

What are the risks involved?

Firstly, investors should be cautious in deciding the debt fund schemes (target schemes in trigger facility) as they carry interest rate and pricing risk, thus there are chances of the gain in equity getting wiped out by the loss in debt schemes. So, it is better to stick to liquid fund schemes for any switch proceeds.
Secondly, if there is any trigger within one year, investors will have to pay short-term gain tax and exit load on your redemptions which can be as high as 16 per cent (15 per cent (STGT) + 1 per cent (Exit Load)).

A little more about dividend trigger in Tata Equity P/E Fund

Tata Mutual Fund has offered a dividend trigger facility in its star performing scheme Tata Equity P/E Fund. This facility allows automatic dividend payments when the net asset value (NAV) of the scheme moves up by a pre-determined percentage, i.e., 5 per cent or 10 per cent. Thus an investor makes most of the opportunity by booking profits or reinvesting the gains when the market moves up, and there is no disappointment on his/her part when the market crashes. So how this takes place actually? Once the NAV appreciates say by 10 per cent, the record date for dividend is announced within 5 working days from the date of occurrence of trigger. Once a trigger is done, no second dividend will be declared in the current quarter. Even if the NAV remains above the trigger level, the next dividend will be declared on the 1st day of next quarter. Thus, possibility of multiple dividend triggers would ensure repeated automatic profit booking by way of dividends at pre-determined trigger levels. It serves as a useful tool against the volatile nature of equity investments. In addition, this method exempts investors from paying any short-term gain taxes and exit loads (if withdrawn within one year) unlike in other trigger options as there is no dividend distribution tax (DDT) on equity-oriented schemes. Some of the mutual fund schemes providing this facility are shown in Table 2.

Conclusion

The idea behind offering trigger facility is simple: to retain mutual fund customers who have become jittery on account of the fluctuating market. So it is no secret that the facility works well when the market conditions are volatile. However, investors must be cautious in selecting the target level for triggers. The choice of target depends upon investment horizon. Investors with a long investment horizon may choose a target from 50 to 100 per cent based on their risk appetite.