If you are an investor in the Indian stock market, then you might have been in situations where you were short of funds. If you have been investing in mutual funds and wondering whether you can pledge them as collateral to get some funds, then you are not alone.

The idea of pledging mutual funds to get some liquidity is a smart financial move because you do not have to sell the units you hold in a mutual fund scheme.Though some brokers give you this option, it is useful to understand about pledging and how it can be used by investors who need funds.

What is pledging?

In the stock market, pledging is the process of using assets like stocks or mutual funds as collateral to secure funds. This is nothing but the investor will get additional margin to invest or trade. The lender, in this case a stock broker, holds the asset until the funds are repaid with interest, and if you default, they can sell the units to recover the amount.

Based on the value of the mutual fund and the type of the fund, the stock broker may provide margin to the investor at a fixed haircut rate. Even though the stock broker has the rights to the units, you are entitled to receive dividend payments.

Advantages of pledging mutual funds

Pledging your mutual funds is a prudent way to access funds when you are in need of it as you do not have to sell your holdings. In this way, you will be able to raise extra capital and at the same time your investments are likely to keep appreciating or earn dividends without interrupting your long-term growth and financial objectives.

When you pledge your mutual funds and raise funds, you are likely to get funds at a lower interest rates compared to unsecured loans or personal loans.

When pledging mutual funds, you can either pledge equity or debt funds that gives you the flexibility. When you hold these mutual funds in dematerialized format, it is easy to pledge. After the margin and interest are paid, the pledge is lifted, and the units are released and you will have full control of your units. This makes it a great option for short-term cash requirement without selling your investment halfway through.

Documents needed for pledging

To pledge your mutual funds, you need to submit a few documents which will be checked before you avail the margin or loan as you may call it.

• For KYC, you need to submit PAN or Aadhaar card or any other valid ID proof authorized by the government of India.
• For address proof, you can submit Aadhaar or driving license or Passport, utility bills, etc.
• You must also submit your mutual fund statement that is recent and has the details of your holdings.
• Then you have to fill up the pledge request form with all the required details and the number of units you are going to pledge.
• Additional documents may be required to be submitted depending on the broker’s terms and conditions.

Things to consider while pledging

When you pledge mutual funds, there are a few things to keep in mind and track them diligently. Markets can change quickly and unexpectedly and if the value of your pledged investments fall, your available margin will fall too. It is always important to be cautious about it and you must ensure that enough margin is maintained in your account.

When mutual funds are pledged, interest is levied on the borrowed amount until the amount and the interest dues are cleared. After this, the units are unpledged and the investor has the authority to sell it.

Pledging is only available for certain mutual fund schemes which are approved by exchanges & clearing corporations and you must always check with your broker which schemes they are allowing to pledge.  

Conclusion

Pledging mutual funds to meet your short-term financing needs can be beneficial as you do not have to sell your investments and let the investment appreciate over time. Pledging of assets gives the investors the option to leverage their existing assets and access funds at lower interest rates. Through this method they can spot many opportunities in the market.