How do mutual funds calculate the reserve for declaring dividends?

In the previous section, we have seen the NAV & accounting & taxation of Mutual Funds. Now, we will explore the mutual fund dividend and distributable reserves.

What is a Dividend?

Before moving forward, let’s recap the meaning of dividend. A Dividend is a distribution of profits from a stock or a mutual fund. 

Calculation of the Reserves for declaring Mutual Fund Dividends

In Mutual Fund schemes, they calculate the reserve for declaring dividends based on their net income and distributable reserves. 

SEBI (Securities and Exchange Board of India) guidelines provide that dividends can be paid on distributable reserves. It is important to keep in mind that the securities need to be sold for the scheme to be sure about the capital gains, i.e., the capital gains need to be realized.

Let’s understand how to calculate the distributable reserves with an example:

• All the profits earned and realized are treated as available for distribution. 

• Valuation gains, which are the paper gains, are ignored when calculating distributable reserves. However, valuation losses are adjusted against profits to account for potential losses.

• The portion of the sale price for new units that is due to valuation gains is not accessible as a distributable reserve. 

Let’s understand with an example

This conservative approach to calculating distributable reserves ensures that dividends are paid out of real and realized profits after providing for all possible losses.