Author: Allirajan M

Budget 2020: Mutual fund side pocket will now tax you less

KV Prasad Jun 13, 2022, 06:35 AM IST (Published)

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Investors in debt mutual funds (MFs), whose investments in fixed income schemes have been assigned to a ‘side pocket’ — means they are segregated from the main portfolio — due to the ratings downgrade of debt securities issued by crisis-hit entities such as DHFL and Vodafone Idea, have something to cheer from the union budget.

Profits from redemption or sale of units from a side-pocket following a recovery would attract the concessional rate applicable to long-term capital gains (LTCG) and not short-term capital gains (STCG). If debt investments are sold after three years, the returns are treated as LTCG and taxed at 20 percent with indexation benefit. Indexation brings down the tax outgo as it inflates the purchase cost.

If debt funds are sold before three years, they are treated as STCG. The gains are added to the income and taxed according to the income tax slab of the investor.

How the change plays out

Currently, units in the side pocket are considered created on the day the portfolio is segregated and not on the day the original investment was made for taxation purposes. This means that investors would end up paying a higher STCG tax for the gains made during recovery.

Union Budget 2020 has changed this by treating them as LTCG for taxation. “In the case of a capital asset, being a unit or units in a segregated portfolio referred to in sub-section (2AG) of section 49, there shall be included the period for which the original unit or units in the main portfolio were held by the assessee,” the Finance Bill said.

“The cost of acquisition of a unit or units in the segregated portfolio shall be the amount which bears, to the cost of acquisition of a unit or units held by the assessee in the total portfolio, the same proportion as the net asset value of the asset transferred to the segregated portfolio bears to the net asset value of the total portfolio immediately before the segregation of portfolios,” it said.

Personal finance experts said a recovery in the side pocket would not be treated as per STCG. Now, the original date of the investment will be valid for the units held in the side pocket also. “Ideally, it (side pocket in a debt MF) should be treated as a new investment. This (treatment as LTCG) is positive for investors,” said Suresh Sadagopan, founder, Ladder7 Financial Advisories.

Only two mutual funds—Tata MF and Franklin Templeton MF—have created a side pocket for investors so far. Side pocketing removes the bad apples from the good ones. In the case of credit events, existing investors potentially lose all value if there is no side pocket.

With side pockets, investors, who take the hit when the credit event happens, get the full upside of a future recovery. When recovery is made in the side pocketed portfolio, the same is distributed among investors on a pro-rata basis.

Allirajan M is a journalist based in Coimbatore.

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Budget 2020: New income tax slabs with no exemptions to hit savings, investments in tax-saving financial products 

KV Prasad Jun 13, 2022, 06:35 AM IST (Published)

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The Union Budget has created two sets of taxpayers and in doing so has totally disincentivised savings. The mishmash of having two different sets of taxpayers — those who avail deductions and the other group who do not and can still avail lower tax rates — doesn’t cure the basic malaise of the sharp fall in savings in recent years.

From a peak of about 30 percent of personal disposable income (PDI) in 2004-05, household savings stood at around 21.4 percent in 2018-19, marking the lowest level in the past two decades.

Under the new regime, taxpayers simply need not invest or save any money to avail of taxation benefits. The budget discourages a ‘savings’ culture. If you invest, you would end up paying more taxes and if you don’t, you may actually shell out less.

In the FM’s own words, a taxpayer “would still be the gainer in the new regime even if he was taking a deduction of Rs 1.5 lakh under various sections of Chapter- VI-A of the Income Tax Act under the old regime”.

If key deductions such as Section 80C of the ‘Income Tax Act’ are not available or are simply not needed to save taxes, buying a house, purchasing tax-exempt mutual funds (MFs), insurance or any other key tax-saver products would no longer be attractive.

This would have a significant impact on inflows into financial savings products such as life insurance schemes, equity-linked savings schemes and even traditional products such as PPF (public provident fund). An individual earning Rs 15 lakh a year would be able to save Rs 78,000 per year under the new regime and he/she can get the benefit by simply not investing any money to avail deductions.

The budget is likely to boost consumption. But the lack of consumption is not the problem. Indians are already spending money at a faster rate than they are earning. Personal consumption growth outpaced the increase in personal income in the decade that just ended (2010s).

The slow growth in PDI and the consequent fall in savings is the real issue that the budget has failed to address. “Although a new tax regime with lower tax rates has been introduced, the removal of all exemptions including even 80C exemptions, will water down its benefits,” said Ankur Choudhary, co-founder and chief investment officer (CIO), Goalwise.com, a direct MF investment platform.

Sunil Rohokale, managing director and CEO, ASK Group, said the option to choose the old or the new income tax regime will just complicate filing income tax returns which were already a complicated process for individual taxpayers.

“This budget is most complex but surely it appears liquidity in the hands of individual and corporate will help consumption and investment,” he said.
“But it massively missed addressing the real issue of joblessness, hopefulness, and confidence in the economy by lack of short-term boosters to get back to 6 percent-plus growth,” he said.

Although the dividend distribution tax has been abolished at the company level it will be taxable at the hands of the investor, according to Choudhary.
Not only has household savings declined, but consumer debt has also increased to record highs in the past few years. Household debt as a proportion of Personal Disposable Income (PDI) PDI has jumped to 46 percent in 2018-19 from 26 percent in 2004-05.

Allirajan M is a journalist based in Coimbatore.

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Budget 2020: Don’t cut taxes, increase deductions

KV Prasad Jun 13, 2022, 06:35 AM IST (Published)

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The economic slowdown has led to a lot of talk about the need to revive consumption growth. But the real problem is that income growth has simply not been able to match the sharp rise in consumption in the last decade. For the first time in the post-independence history of India, personal consumption growth outpaced the increase in personal income in the decade that just ended (2010s). Simply put, Indians are spending money at a faster rate than they are earning.

Household real personal disposable income (PDI) has grown at an average of 6.2 percent in the 2010s. However, real personal consumption expenditure (PCE) surged 7.6 percent, the highest decadal growth since Independence.

Consequently, not only household savings have fallen sharply but also its leverage has increased markedly during the past few years. While household debt as a proportion of PDI has jumped to 46 percent in 2018-19 from 26 percent in 2004-05, household savings has steadily declined to 21.9 percent from 29.5 percent during the timeframe.

The prescription to cure this malaise — don’t cut taxes but increase income tax deductions as this will boost savings, say experts and market veterans. The forthcoming union budget should avoid the strong urge to boost consumption spending by cutting personal income taxes because the problem lies in subdued personal income growth, they say.

If personal consumption is incentivised but income growth remains weak (as has been the case over the past 6-7 years), the economy will remain structurally vulnerable and in fact worsen faster. Personal savings should be incentivised by increasing the deduction limits under various sections (80C, 80E, 80EE, etc.).

Incidentally, the deduction under Section 80C, which is limited to Rs. 1.5 lakh now, was last raised in 2014. The limit then was just Rs 1 lakh under Section 80C, the most popular option among taxpayers. “With a variety of investments and payments already getting covered under this section (80C) — contribution to PF (provident fund), NPS (national pension scheme), tuition fees and repayment of housing loan itself consumes the limit and hardly leaves any scope for saving in other eligible investments. Raising the limit to Rs 2.5 lakh will help taxpayers to save more for their future,” says Kuldip Kumar, Partner & Leader, PwC India.

“Although it (higher tax deductions) will entail small fiscal costs and may hurt personal consumption growth over the short-term, it could potentially address the most serious structural issue and help ease the domestic financial markets, which would help lower interest rates,” according to Nikhil Gupta and Yaswi Agarwal of Motilal Oswal Financial Services.

Boost personal savings and investments

At present, the Income Tax Act does not provide a focused benefit for housing. The lack of exclusive tax benefit on the principal amount of home loans has been a dampener, say industry officials. “A separate annual deduction of Rs 1.5 lakh for principal repayment (on home loans) will provide the much-needed fillip to housing sales,” says Shishir Baijal, Chairman & Managing Director, Knight Frank India.

An increase in the deduction for interest on loan for residential house property (section 80EE) would also boost personal savings and investments, say industry officials. The move would spur the residential property sector and the cost to the exchequer, estimated at Rs 270 crore in 2018-19, would also be very low.

From a peak of about 30 percent of PDI between 2003-04 and 2011-12, household savings stood at around 22 percent in 2017-18, marking the lowest level in the past two decades. Not only has household savings declined, but consumer debt has also increased to record highs in the past few years. The combination of falling savings and rising debt has weakened the balance sheet of India’s household sector. The repair work could well begin with the budget which can gently nudge taxpayers to save more by increasing deductions.

Allirajan M is a journalist based in Coimbatore.

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Side pocketing mutual fund losses: Removing bad apples from the good ones

KV Prasad Jun 13, 2022, 06:35 AM IST (Published)

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Franklin Templeton has become the latest fund house to offer a ‘side pocket’ to investors in its fixed-income schemes hit by ratings downgrade of debt securities issued by crisis-hit Vodafone Idea. The board of trustees of Franklin Templeton Mutual Fund (MF) has approved the creation of ‘segregated portfolio’ or a side pocket in six of its fixed income schemes— Franklin India Credit Risk Fund, Franklin India Short Term Income Plan, Franklin India Ultra Short Bond Fund and Franklin India Income Opportunities Fund.

With effect from 24 January, various securities issued by Vodafone Idea, in the abovementioned schemes, will be segregated from the total portfolio. “This decision has been taken in order to protect value for existing unitholders in these schemes. These securities have already been marked down by us to a value of zero, on January 16,” Franklin Templeton MF said.

While side pocketing is in vogue in several developed economies, markets regulator Sebi allowed it in debt schemes of MFs only in January last year. Tata MF was the first fund house offer a ‘side pocket’ to investors in the country by segregating the portfolio of securities of crisis-hit mortgage lender DHFL held by its debt schemes last June.

So how does a side pocket work? The side pocket is generally formed by the creation of a separate portfolio of distressed, illiquid and hard-to-value assets. Each investor is allocated his/her pro-rata interest in the side pocketed portfolio. To put it simply, side pocketing removes the bad apples from the good ones.

In case of credit events, existing investors potentially lose all value if there is no side pocket. With side pockets, investors, who take the hit when the credit event happens, get the full upside of a future recovery. When recovery is made in the side pocketed portfolio, the same is distributed among investors on a pro-rata basis.

What impact does it have on investors? You cannot subscribe or redeem (exit) your units in a side pocket portfolio. The fund house would transfer the money to the investor in the segregated portfolio of the troubled investment (for example DHFL, Vodafone Idea) when the debt security matures.

You can also get money if the fund house is able to sell the troubled securities after an upgrade from credit rating agencies. Typically, an upgrade would result in an improvement in liquidity for the troubled investment offering a window of opportunity to exit.

Personal finance experts say that ‘side pocket’ is a useful tool for investors. In the absence of a side pocket, there would be huge redemption pressure. The fund house would have to sell good quality securities to meet redemption requirements.

How would the portfolio look like after a side pocket is created? The number of MF units in both the side pocketed and the regular portfolios would be shown as the same. However, the net asset value (NAV) of the portfolios would be different. In the case of the fixed income schemes of Franklin Templeton MF that have taken a hit—the exposure to the downgraded securities of Vodafone India was 4.1-6.5 percent of their respective total AUM.

A statement of account indicating units held by the investors in the main and segregated portfolio along with the respective NAVs as on the day of the credit event will be communicated to the investors within five working days of the creation of the segregated portfolio.

Though units of the segregated portfolio will not be available for subscription or redemption, the AMC (asset management company) will enable listing of units of the segregated portfolio on the recognised stock exchange within 10 working days of the creation of the segregated portfolio and enable the transfer of such units on receipt of transfer requests.

Upon recovery of money from the issuer in the segregated portfolio, whether partial or full, it will be distributed to the investors in proportion to their holding in the segregated portfolio. No investment and advisory fees can be charged by the AMC on the side pocketed portfolio.

However, TER or total expenses ratio (excluding the investment and advisory fees) can be charged on the side pocketed portfolio but only upon recovery, on a pro-rata basis i.e. on the recovered amount. Franklin Templeton MF has restricted fresh inflows in these schemes to Rs 2 lakh per day per fund per investor, till further notice. This limit is imposed only on the new applications received after the cut-off time on January 16.

Allirajan M is a journalist based in Coimbatore.

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Long duration debt, gilt funds top charts on bond rally, but investors need to be cautious

KV Prasad Jun 13, 2022, 06:35 AM IST (Published)

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Debt mutual funds (MFs) may have found themselves in a tight spot due to defaults and delayed payments of securities owned by troubled entities such as IL&FS and DHFL. But long-duration debt and gilt funds have been among the best performers in the last one year following the sharp rally in bond prices.

Long duration debt funds topped the performance chart in the fixed income category delivering 12.1 percent returns on average in the last one year. Gilt funds, which invest primarily in government securities (G-Secs), came a close second. While gilt funds that invest in securities with a 10-year duration gained about 12 percent, gilt funds with exposure to shorter duration instruments increased by 10.4 percent during the one-year timeframe. These funds have beaten most equity MFs and their fixed income peers by a good margin.

The fall in yields has pushed up bond prices benefiting these funds. The benchmark 10-year government bond yield has dropped to around 6.5 percent, 100 basis points (1 percent) lower than a year ago and the lowest since 2017. Bond yields and bond prices are inversely related. Rising bond prices help these funds earn higher returns, which typically gain the most when yields or interest rates start falling.

The Reserve Bank of India (RBI) lowered the benchmark repo rate, the rate at which the central bank lends money to commercial banks, by 25 bps (0.25 percent) to 5.15 percent, its fifth rate cut in 2019, in early October. The RBI had cut repo rates by 135 bps (1.35 percent) in 2019 pushing it to the lowest level since late 2010.

Susceptible to interest rate risks

“These (long duration) funds clocked double-digit returns as (bond) yields came off,” said Lakshmi Iyer, chief investment officer (CIO) (debt) and head, products, Kotak Mahindra MF. As a result, long-term bond funds emerged as the best performers in the fixed income category in 2019. With the yield on the benchmark 10-year bond falling from around 8 percent to 6.5 percent since 2018, bond prices started to rally.

“These are cyclical funds and tend to do well when interest rates go down and vice versa,” said Maneesh Dangi, co-CIO, Aditya Birla Sun Life MF. Long duration debt and gilt funds have high exposure to G-Secs. The top-ranked fund has gained nearly 13.1 percent in the past one year, which is among the best in widely traded assets.

These funds, however, are highly susceptible to interest rate risks. They have in fact given negative returns in years when interest rates rose sharply. Industry officials and experts also advise caution on investing in these funds as the rally in bond prices is unlikely to sustain in 2020.

“The yield on long-term bonds may not come down significantly in 2020. So, it would be difficult for these funds to repeat the performance (of 2019),” Iyer said. “The yield on the 10-year government bond is already low. The chances of it going down further is quite less,” a senior industry official said.

Gilt funds, which delivered double-digit returns in crisis-ridden 2008 when the RBI cut rates during the end of the year, moved into the negative zone after interest rates started rising in the following year.

Similarly, they delivered double-digit returns in 2001 and 2002 as well when interest rates fell. Given the risks, some experts believe that investors are better off if they invest in dynamically managed bond funds.

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Lost decade: Indian stock markets lagged global peers in 2019, decadal Nifty returns just about match gold’s

KV Prasad Jun 13, 2022, 06:35 AM IST (Published)

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Stock markets are often seen as a barometer of the economy. Even as economic growth plunged to new lows, benchmark indices continued to scale new peaks with foreign institutional investors (FIIs) pumping $14.2 billion into the Indian equity markets in 2019, the highest in five years. Though the performance of the stock markets looks impressive, they are no match compared to global peers.

The Nifty’s returns in 2019, at 12 percent, was way below that of benchmark equity indices of the US, Japan, Brazil and Russia. In fact, it did only better than South Korea and Indonesia in local currency terms among major stock markets during the year. Emerging markets (EMs) outperformed India by a wide margin during 2019. Over the last 12 months, MSCI EM gained 15 percent outperforming MSCI India index that advanced 8 percent.

The story gets less rosy if long-term performance is taken into account. While India improved its rank in terms of global market capitalisation from 17th to 8th over 2004-2010, backed by an impressive average GDP (gross domestic product) growth of 8.8 percent during the timeframe, in the decade (2009-19) that just ended, the country improved its global market cap ranking by just one notch from 10th position in 2009 to 9th in 2019. It had taken the 9th position during the market rout that followed the global financial crisis in 2009 but improved to 8th position after the sharp rebound in 2010. Though it climbed up to the 7th position in 2018, it had slipped to 9^th in 2019.

In fact, Nifty’s compounded annual growth rate (CAGR) of 8.9 percent in local currency terms during the last decade was no better than the gains made by gold. The CAGR of bank fixed deposits (FDs) and 10-year government securities (G-Sec) stood at 7.7 percent between 2009 and 2019. The CAGR of Nifty increased at a slower pace than the nominal GDP growth rate of 13 percent in the last ten years.

Tepid corporate earnings hurt equity returns

India’s market capitalisation also advanced by a mere 3 percent year-on-year to $2.1 trillion in 2019, the lowest pace among major and emerging markets. “Consequently, market cap-to-GDP is below long-term average,” Saurabh Patwa and Sankalp Baid, analysts at HDFC Mutual Fund (MF) said. India’s share in world market cap is now at 2.5 percent, in line with its historical average.

The decade ending 2019 was characterised by relatively tepid corporate earnings, which impacted equity returns, market observers said. “For several years now, strong growth in profits has been elusive,” they said. The slowdown in the profit growth of companies on the Nifty index was led almost entirely by the fall in profits of corporate banks. The share of corporate banks in the consolidated profits of Nifty companies fell from 12 percent to 3 percent between 2012-13 and 2018-19.

“Weak credit cycle, which impacted profitability of the banking system, moribund investment cycle that impacted profits of capex-oriented sectors – power, capital goods, metals, cement, real estate and sector-specific headwinds (such as telecom) cumulatively impaired corporate India’s bottom line in the decade,” said Gautam Duggad and Deven Mistry of Motilal Oswal Financial Services.

Nifty’s EPS (earnings per share) CAGR is forecast to be around 8.2 percent between 2009-10 and 2019-20, almost mirroring the index’s returns during the timeframe. Earnings were relatively healthy in the first half of the decade with Nifty’s EPS CAGR standing at 11 percent between 2009-10 and 2014-15.

However, banking asset quality issues came to the fore in 2015-16 with the Reserve Bank of India mandating asset quality review of banks and subsequently recognition, provision and resolution of NPAs. This had taken a toll on corporate earnings with Nifty’s EPS CAGR projected to advance by a meagre 5.6 percent between 2014-15 and 2019-20.

Over the last 10 years, Reliance Industries, HDFC Bank, HDFC, ICICI Bank, Infosys, ITC and L&T have maintained their position in the top-10 by weightage terms in the Nifty. Maruti, Axis Bank and Sun Pharma have been part of the index for the past ten years but featured in the top 10 just once over this timeframe. SBI and Tata Motors have been in the top-10 for five out of ten years. ONGC, HUL and Bharti Airtel have appeared twice in the top 10.

Allirajan M is a journalist based in Coimbatore.

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