One of the benefits of mutual funds is that there is liquidity available for. The common way for investors to deal with their units is through the mechanism of repurchase and sale that is available for open-ended funds. There is another angle to the entire investment process and it’s about transfer of fund units. Often there are restrictions on this route and this can throw investor’s plans out of gear and may even hold up the objectives that one has been trying to achieve. The market regulator has now advised fund houses to relax these rules and this will benefit investors.

Nature of activity: The term ‘transfer of units’ is slightly different from other actions involving mutual fund units. Under normal operation of open-ended funds, an investor buys or sells units to the fund house. What this means is that the fund house is at one end of the transaction. When units are bought from investors, they are immediately cancelled, and when units are sold to investors, new units are created. These actions are called repurchase and sale of units. There is another option available in the form of transfer of units from one investor to another without creation or destruction of units. In this case, the ownership of fund units changes, but the number of units is not affected.

Restriction: There is a guideline related to mutual funds that says a unit shall be freely transferable unless it is prohibited or restricted under the scheme. The intention is to ensure that the units are freely transferable, but the actual impact is completely the opposite. It has been seen that in many cases a fund house has sought to put restrictions on transfer of fund units. This reduces the scope of activity for investors. For example, if there is a restriction on the transfer of units and if a father holding 2,000 units of a fund wants to distribute 1,000 units each to his two sons, he will not be able to do so directly. Taking note of this situation, the market regulator has asked fund houses to ensure that fund units held in demat form are freely transferable.

Listed units: Earlier there was a situation wherein close-ended schemes were listed on stock exchanges and the only way an investor could exit a fund was by transfer of units on the exchange platform. However, there has been a drop in the number of such funds. At the same time, there has been another development. One can now hold mutual fund units in demat form. Restriction on transfer of fund units in demat form will overturn the very basic benefit available in demat facility. However, with the new guidelines in place, this will be a boon for investors, as it will facilitate easier transfer of fund units.

ELSS: There are a few situations where transfer of fund units will not be possible even in the demat format because of the very nature of investment. This is on account of the lock-in clause attached to such investment. This will cover equity-linked savings schemes, which are tax-saving instruments. Investment into these funds allow an investor to claim deduction under Section 80C, but it comes with a three-year lock-in. When this is the case, the investor will have to ensure that the holding would have to be held for the stipulated time period and the lock-in is not violated. In such a case, even if an investor transfers fund units into demat form, there will be a restriction for a three-year period. Similar will be the situation for pension funds offered by mutual funds, where there is tax saving and a mandatory three-year lock-in.

Use: The most important point for investors is that they will have to use the transfer facility in an effective manner. There are a number of conditions under which the transfer facility is useful. It can be used when there is sale of units that is most common. There can also be a unique situation where an investor may require to transfer fund units due to partition or separation of assets and this facility will be useful here too.

(The writer is a CA andCertified Financial Planner. This column will appear every Monday.)