Invent a theory, and let investors follow

Vivek Kaul
Friday, March 03, 2006 21:37 IST


Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. — John Maynard Keynes, the greatest economist of the twentieth century
MUMBAI: Every bull market has a theory behind it. The theory puts across the “reasons for investing in the stock market”. At other times, it explains why the market is rightly valued when evidence suggests otherwise.
Even at times when an individual or a group is rigging the stock market, it helps convince investors to come and join the party.
The theory is essentially used to influence the investor’s perception of the stock market. As Harshad Mehta, the original big bull, remarked in an interview to a business magazine, “The crucial thing about stock markets is that they are primarily driven by perceptions, not performance. That’s unlike the commodity markets, which are more performance-oriented.”
Mehta had his favourite theory, too, — the replacement cost theory. When he rigged up stocks like ACC, he justified the inflated price using this theory. And what did the theory say? “The market capitalisation of ACC (as well as the other stocks that were rigged) should be at least equal to the money required to create another ACC.”
He backed up this theory with some really media-friendly comments, “I thought I’d be like Pied Pier. I thought I can sell dreams... that asset-creation is not a crime, that if you wanted to be Harshad Mehta, come to the stock market.”
After Mehta’s downfall, this theory has been confined to the dustbins of history, at least, as far as the Indian stock markets are concerned.
The next big bull was Ketan Parekh. Parekh was not as media- friendly as Mehta was. But stock market experts picked up on his investment style and justified it by saying that the companies he has invested in have been selected for investment with help from his research team.
The research team, they said, had listed out stocks with a low capital base and a low liquidity. And this convinced not only ordinary investors, but also foreign institutional investors and mutual funds. The FIIs and funds bought stocks Parekh had invested in, even after he had more or less exited them.
Another theory that has gained currency among analysts in recent times is the ‘sum of the parts theory’. This is applied in case of companies which are in multiple businesses. The profits of such a company are essentially made up of profits through its multiple businesses. But the stock price at a given point of time may not have captured the right value of the various businesses.
Thus the logic: stock is cheap. Using this theory, analysts remained gung-ho on Reliance even after its recent demerger. Most analysts expected the price of the Reliance stock in the range of Rs 700-800, post-demerger. They used the sum of the parts analysis to justify the price.
The price of the Reliance stock before the demerger, they felt, did not rightly value its investments in financial services, power and telecom.
Since so much information is available these days, something insightful can always be said about each and every market event. And this makes truly random happenings in the market look like they happened due to some reason.
Also, a lot of stock market experts are very intuitive. But intuition cannot serve an investment argument. Thus, a theory through which one can convince the investors to invest.

Take small steps to ensure better returns

Regular investing helps if you do not have a large amount of money to invest
Vivek Kaul
Mumbai

It was two hours past midnight and Kavi Kumar was still awake. He was thinking about the woman with long hair who had been taking the 10.44 a.m. Churchgate local from Andheri, along with him, for the past few days. The first thing that hit him about her was that her hair was not coloured. Kumar was whistling an old Peter Sarstedt number, But where do you go to, my lovely ,When youre alone in your bed, Tell me the thoughts that surround you, Want to look inside your head, yes I do. And since all good things come to an end, he suddenly remembered he still has not done his tax planning for the year. He thought he should invest some amount in equity-linked savings schemes (ELSS). It was one of the investment avenues under Section 80C, where he could invest up to Rs 1 lakh and claim tax deduction. The next day, Kumar went to the bank and invested Rs 60,000 in one of the tax-saving schemes. There he got introduced to Ashish Subramanian, a wealth manager with the bank. Subramanian asked Kumar “Why did you invest Rs 60,000 at one go?”“Well, for the simple reason that I have to invest before March 31, 2006, if I want to avail tax benefits,” replied Kumar. “But what was stopping you from investing smaller amounts regularly throughout the year?” Subramanian, retorted. Kumar couldnt give a reply. “If I had invested regularly in tax planning funds, would that have helped?” asked Kumar. “Well, to give you a very simple answer, regular investing helps if you do not have large amount of money. But that would be a very simple way of looking at it. Lets take your example. You invested Rs 60,000 at one go on March 1, 2006. Lets assume you had purchased the units of HDFC Tax Saver fund. The net asset value (NAV) of the fund, as on March 1, 2006, was Rs 119.134. Other than this, the fund would have also charged you an entry load of 2.25% of the NAV. So, the price of a single unit would have been Rs 121.815 (119.134 +.0225 X 119.134). Thus, the number of units you would have been able to buy is 492.552. Now, instead of investing in one go, if you had invested on the first day of every month (or the next possible day, if the first day was a holiday) starting from April 1, 2005. Every month, you invest Rs 5,000, so that by the end of the year, you have Rs 60,000 in tax-saving schemes. This regular investing in mutual fund jargon is known as investing through a systematic investment plan (SIP). In case of an SIP, mutual funds charge a lesser entry load. For HDFC Taxsaver, the entry load is 1% of the NAV. After investing regularly every month, you would have ended up with 658.114 units whose market value would have been Rs 78,403.70,” Subramanian said.“Is this phenomenon common to other tax-saving funds?” asked Kumar. “Lets take the case of Prudential ICICI Tax plan. If you had invested Rs 60,000 on March 1, 2006, you would have got 741.467 units of the fund. Instead, if you had invested Rs 5,000 regularly at the start of the month, you would have ended up with 961.197 units, whose market value would have been Rs 76,069.17,” replied Subramanian. (The example is hypothetical)

Now, avail of tax benefits on fixed deposits

FDs with a term of not less than 5 years have been included under Section 80C
Vivek Kaul
Mumbai

Malti Kasbekar had spent considerable time listening to the budget speech on Tuesday. She was particularly interested in figuring out what the finance minister had laid out for a common person like her. Malti felt the speech was too boring. She remembered days of yore when the earlier finance ministers like Manmohan Singh and Yaswant Sinha had interspersed their speeches with couplets of Ghalib. Her father-in-law, who was also watching the speech, reprimanded her for this. “The government budget is a serious activity and may or may not entertain, like your favourite daily soaps,” he said. Point taken. Malti started paying attention to the speech. Towards the end of the speech she heard the finance minister saying the word — fixed deposits (FDs). Her husband had most of his investments in FDs. The FM had included FDs, with a term of not less than 5 years made with banks, under the current basket of instruments under Section 80C of the Income Tax Act, 1961. Under Section 80 C, taxpayers can make an aggregate deduction of up to Rs 1,00,000 from their gross income for certain kinds of investments. This decision of FM made her happy. Her husband was very lazy when it came to financial planning. He had all his money in fixed deposits. But this did not help in tax savings. Earlier, till financial year 2004-05, under Section 80 L of Income Tax Act 1961, a tax deduction of up to Rs 12,000 was allowed for interest earned on FDs with banks. But with low interest rates on FDs very little deduction was possible. With the introduction of Section 80 C in the last budget this deduction was no longer allowed. Now, with fixed deposits coming under Section 80C, investors who are lazy at financial planning will benefit the most. But as far as returns are concerned there are better options available in the market right now. National savings certificate (NSC) VIII is one of them. It has a six-year maturity period. In order to claim a tax deduction for investing in Fds one has to invest for a minimum of five years. The interest rate on FDs of maturity greater than or equal to five years is around 6.5%- 6.75% vis-a-vis NSC VIII, which gives an interest rate of 8%. Also the investments will be locked in for a similar period in both the cases. Further, if one is ready to lock-in investments for a greater period, then public provident fund (ppf) is another good option available to the investor. The investment here is locked in for a period in between 15-16 years. The interest payable in this case is also 8%. Investments made in NSC VIII and PPF are allowed for a tax deduction under Section 80C. Though in case of PPF, an investor cannot invest more than Rs 70,000 in a given year. This move makes a bank fixed deposit with an interest reinvestment of interest option very similar to NSC VIII as far as the structure is concerned. In case of NSC VIII the interest accumulates and is not paid to the investor every year. The interest that accumulates is treated as invested in NSC VIII. Hence it qualifies for an exemption under Section 80 C for the first five years. In the last year, the interest is handed over to the investor and hence does not qualify for a deduction and hence is taxable.Tax experts are of the view that if the investor opts for a reinvestment of interest option in case of fixed deposits, the accumulated interest would also be eligible for a tax deduction under Section 80 C. And like in case of NSC VIII the interest earned in the last year of the fixed deposit would be taxable. But if the investors opt for a monthly or quarterly interest payout option while investing in a fixed deposit, the interest they earn would be taxed depending on the marginal tax bracket they fall into. (The example is hypothetical)

Tax change means balanced funds will tank up on equity

Budget provision calls for 65% equity to escape tax net
Vivek Kaul
Mumbai


The budget-induced change in dividend distribution tax rules could force many balanced funds to increase their equity investments to avoid having to pay this tax. Balanced funds are supposed to balance their investments between debt and equity, with some tilting towards equity and the other towards debt.Mutual funds have to pay a dividend distribution tax of 12.5% to the department of income tax every time they declare a dividend. This, however, does not apply to open-ended equity-oriented funds. These are defined as mutual fund schemes wherein more than 50% of investible funds are invested in the shares of domestic companies. The budget for the year 2006-07 has raised this level to 65%. This amendment comes into a play from June 1, 2006. When this happens, it will affect those mutual fund schemes whose equity components constitute between 50% and 65% of the assets - that is, mostly balanced funds. These funds will have to pay a dividend distribution tax as and when they declare dividends. When a mutual fund scheme declares a dividend, its net asset value (NAV) goes down. On top of that, if the scheme also needs to pay a dividend distribution tax, the NAV will come down further. To avoid the tax, balanced funds will have to increase their equity exposures, making them less balanced in the process. As on January 31, 2006, there were 36 balanced funds in the market. Of these, 15 schemes have an equity component between 50% and 65%. The total assets under management (AUM) of balanced funds as on January 31, 2006, was Rs 7,088 crore. This forms 8.7% of the total AUM of equity-oriented schemes, which include schemes that are not debt, gilts, income or liquid. The AUM of balanced funds whose equity component is between 50% and 65% comes to around Rs 4,368 crore. This forms around 5.4% of the total AUM of the industry. Given this statistic, the conclusion one can draw is that the change in the regulation will not rock the mutual fund industry. “The impact will be less. Most of the balanced funds have an equity component in the range 60%-70%. Also, the AUMs of these funds are not much”, says Sameer Kamdar, National Head - Mutual Funds, Mata Securities India Pvt Ltd.