``Dividend payout in equity funds does not make much sense since these funds are meant for long-term growth. However, with Indian investors attaching much importance to payouts and dividend being made tax-free, AMCs have declared payouts, and those without a dividend option have offered the same to their investors,'' says a mutual fund head.

``Thanks to the current rally, investors in the dividend options of some schemes have even seen their net asset values (NAVs) rise back to pre-dividend levels in a short span,'' he adds. With theintroduction of tax-free dividends, however, the spectre of dividend stripping looms large over open-ended equity funds. Industry sources say that there have been instances of dividend stripping in most of the equity funds, albeit on a small scale.

In dividend stripping, short-term investors enter a fund which has declared a dividend and move out as soon as the NAV goes ex-dividend, booking a capital loss. While dividend earned is tax-free, the capital loss can be adjusted/matched against past or future capital gains in a short span. Thus, investors need not invest in schemes with Sections 54EA or EB to avoid paying tax on their capital gains.

``Mutual funds will have to live with dividend stripping since it cannot be avoided. Some amount of short-term money will always flow into an equity fund, although most of the times, the investor puts the money in some other scheme of the same AMC after stripping of dividend,'' says an official of a mutual fund.

However, a large inflow of investments for dividendstripping can destabilise the fund. ``When this money moves out after earning dividend, the fund managers will be forced to offload stocks in the market, which will hit the NAV and adversely impact long-term investors,'' says an analyst.

Industry sources point out that while entry or exit loads hardly act as an effective deterrent, mutual funds can reduce incidence of dividend stripping by not aggressively advertising their payouts. ``For instance, Alliance Mutual Fund declared a payout of 20 per cent in Alliance '95 but did it in a very subtle manner. They did not splash any advertisements,'' says an industry observer.

Despite the NAVs of many equity funds being above Rs 20, the payouts have been restricted to around the 20 per cent levels. ``At our NAV of Rs 30, even a payout of even 100 per cent is feasible, but we do not want to promote an unrealistic picture. ``It may so happen that next year, even a payout of 20 per cent becomes difficult,'' says the head of a mutual fund.