According to an interesting report printed in The Times of India, mutual funds (MF) have hit upon the idea of announcing dividends well before the record date, so that punters can enter the fund, collect the dividends and exit, all within a few days.

The investor who is normally a high networth individual investor, private bank or corporate, invests in a MF on or just prior to the record date. Once the investor becomes eligible for the dividend, he/it exits from the scheme. The dividend is tax-free in the hands of the investor. Moreover, he exits at a lower NAV (which gets reduced by the dividend amount) and suffers a short-term capital loss, which can be set off against capital gains.

Further, the MF may levy a higher exit load, in which case the investor suffers a higher capital loss, which he is free to set off against his capital gains.

In this whole process, the genuine long-term investor is the loser. Moreover, as the MF encourages this practice to show 'large inflows' it does not invest the money in long-term assets. As a result, the NAV stagnates, depriving the genuine investor of capital appreciation.

Moreover, as more investors have entered the fund to collect dividends, the dividend payout is for a larger number of units. The MF has to liquidate some of its investments to meet dividend requirements. This is done through the sale of good stocks, as 'dud' stocks would not be easy to liquidate. This may leave a few dud stocks in the MF portfolio, as good stocks would have been sold off. The quality of the MF's portfolio would be adversely affected, jeopardising the MF's long term prospects.

The exchequer also loses out as short-term capital gains are rendered tax-free by a notional short-term capital loss.

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