The intention of the new Rajiv Gandhi Equity Savings Scheme (RGESS) is laudable; the problem is in the way this scheme has been outlined. The goal of ?bringing in huge capital through 1.5 crore new investors who have an income of up to R10 lakh but who do not have a depository account? is more driven by the temptation of this kitty. The scheme appears to be more a reactive solution to the current bear run, and not about how to ensure that we convert our nation of cautious savers into a nation of informed investors on a sustainable basis.
The problem with ?new? investors !
The scheme is aimed at that huge population that has never ever bought a single share. Given the long history and regularity of scams, it should be recognised that most such people place first emphasis on safety, only then followed by returns and liquidity. For them, return of capital is now more paramount than return on capital, as shown by their continued preference for low-yielding bank deposits or illiquid investments like gold. Hence, they consider capital market as a minefield, and even a tax break will not be sufficient for them to risk their capital. At best, a new retail investor would save only about R5,000-R7,500 in taxes on an investment of R50,000. Should we even encourage a scheme where the lure of R5,000-R7,500 puts at stake the capital of R50,000? The balance people believe that the capital market is a complex domain, beyond their comprehension.
Equity, by its nature, is a high risk-high reward instrument, and can also turn out to be high risk-low reward, and that is also how most people see it. As such, risk-averse people will not bite in. That equity is very risky is proclaimed boldly by Sebi itself, which , for example, has a disclaimer on the cover page of each prospectus warning that investment should be made ?only if the investors can afford to take the risk of losing their investment?.
During the last quarter of every year, when most savers are seeking, and are hawked, a variety of tax saving schemes, they fall easy prey to them. With RGESS too, they may end up buying, or getting sold, all the ?cheap? and wrong stocks. This is dangerous. They may, on their own or based upon tips and ?advise? of financial intermediaries, end up losing money, and then forever abandon the market. That will be bad for the economy as we will lose such savers for ever, like we have lost lakhs of investors stung by the vanishing companies scam of the 90s where tens of thousands of crores just evaporated.
Another issue with the scheme is with the term new investors itself. New can have only one connotation: people who have never ever bought a single share of a listed company. The only valid way to determine the ?newness? would be to ensure that the person does not, as on date of buying his first equity share under this scheme, have a depository account. It is another matter that millions of investors of the pre-1995 period who got shares allotted in physical form and never got these dematerialised, will be able to participate under the new scheme as it would almost be impossible for anyone to determine their physical holdings (the only alternative being obtaining an affidavit from every investor that he has never invested in equity shares!). By the same logic, RGESS should exclude any person who has ever invested in a pure equity mutual fund scheme, as he too technically is not a new equity investor.
But why should a one-time, two-time or genuinely small investor be excluded from this scheme? What happens to a person who opened a depository account to apply in an IPO, but never got any shares allotted due to huge oversubscriptions, but his depository account, though with a zero balance, continues? Why should we exclude a small investor who got allotted say just 5-10 shares in an oversubscribed IPO as his first and only investment (and there would be millions of them), and who is either still holding these or has sold these off and has a zero balance in his depository account or has even closed his depository account? And what about millions of investors who hold physical shares but have still not opened a depository account, either because those shares are illiquid or because they are long-term investors and do not want to incur either demat charges or custodial charges year after year or simply because they want to hold on to physical shares as they never intend to sell those.
For simplicity in operation, the word new should be dropped from the proposal. Anyways, a person who holds shares of less than R50,000 is a tiny investor (Sebi?s definition of a small investor is one who puts in an IPO application of up to R2,00,000), and whether he has invested in equity in the past or not is immaterial.
Only listed stocks shall qualify!
Thankfully, while the policy announcement covered all stocks, and there are 4000+ of these, it has subsequently been recognised that this could be extremely risky as investors may even pick up penny stocks. Hence, it is now being stated that investments only in the top stocks, say as included in BSE-100, would be eligible. But assuming that BSE-100 stocks are safe and will offer profits is as far from truth as can be. It is disconcerting to hear some recent official announcements that ?once the retail investors taste profit and feel their money is safe, they can go for more investments?. These are based on two wrong premises: that profits are assured and that equity is safe.
The reality is that the constituents of BSE-100 keep changing… the not-so-good companies are continuously taken out and replaced with the emerging good ones. The list of top 100 may be good, but only on a particular date… but 1 or 3 years later? A study shows that in the last 3 years, as many as 19 companies were removed from the BSE-100, and that in the last 1 year alone, as many as 11 companies have been moved out, and that on both 1-year and a 3-year horizon, a large number of these stocks generate not positive, but negative, returns. The same also holds true for the very top companies?the Sensex (top 30) companies. Over the last 3 years, as many as 7 companies have been moved out, including 3 in the last year alone. Worse, even Sensex companies do not necessarily mean high or even adequate returns. According to a recent study, as many as 75% of the Sensex companies gave a negative return over the last financial year period (forget about profits)!
Perversely, could limiting to BSE-100 actually lead to providing the large investors, who have better recourse to insider information and research, a ready exit opportunity from companies that they come to know in advance are not expected to perform well in the future, and thereby heap these shares on the gullible retail investors, by building a hype with the help of pliable media and financial analysts?
Biggest problem: primary market excluded!
However, the biggest problem, and the most fundamental one, is that the suggestion of eligibility of BSE-100 stocks automatically implies that the scheme will only recognise purchases of an already listed stock and not those acquired in the primary market. This scheme as such is encouraging trading activity where the monies flow from one person to another, and is not aiming at capital formation which happens only through the primary market route.
In the 80s, there used to be a tax benefit under Section 80CC where the objective was double fold: get retail investors into equity by offering them tax benefits, and encourage industrial development. One, only such companies were eligible which were being set up in backward areas, in order to encourage a well-balanced industrial development. Second, the tax benefit was available only for investing through the IPO route, and not for buying from the secondary market. As such, if the intention is to encourage investing, then the secondary market should be excluded from the scheme.
As we want to encourage investors, and not traders, the tax benefits should be available only in the IPO route. The primary market has been lying moribund for long now, and the corporate sector and the economy are suffering because of lack of capital. However, to protect small, uninitiated investors, only certain classes of companies should qualify; this can be defined in terms of sector (example infrastructure) or issue size, or presence of term lending or a 3-year profitability track record or location in certain specified zones and all PSU IPOs.
For PSU IPOs, in specific, instead of offering a tax benefit, a better, simpler and also populist measure would be to increase the allocation for retail investors in all PSU offerings (from the present 35% to may be 75% or even to 100%), and offering a 15% discount on all applications below R50,000 (or even R1,00,000). This would not only bring in the capital that PSUs need, but also bring in millions of new investors?an avowed statement in the Congress Party manifesto is that it wants every household to own a PSU share. Offering any discount to anonymous individual investors is free from any allegation of favouritism. In any case, this would mean sharing of public wealth with the public only. A 1-year lock-in can be imposed.
Why lock-in?
Aggravating the investors? plight is the proposal of a lock-in (of 3 years which now is being proposed to be reduced to 1 year). This is contrary to the avowed belief that liquidity is a major ingredient of an efficient capital market. The objective clearly is that people should come into this scheme with an investors? mindset and not a traders? mindset, and that flippers should be discouraged. But a lock- in? This is based on a wrong belief that some thing should be extracted in lieu of the tax break, but even more wrong is the premise that equity investments only grow in returns over time.
Imagine the misery of a new retail investor who picks up some companies from the BSE-100, and then finds that after the lock-in is over he is stuck with a bad stock! Over the lock-in period, he sees the prices of his shares tumbling down, which can be for a wide variety of reasons. If he sells out, with the sane policy of cutting losses, he has to refund the tax benefit. If he does not sell out, he may haplessly watch his capital erode! The benefits should be real, sufficient and sustainable to attract the penalty of a lock-in.
Why are mutual funds excluded?
Worldwide experience has shown that small investors should not invest directly, but do so through a professional, and for this the mutual funds route has been found to be most suitable and sustainable. As such, the policy should be made applicable only on investments made in equity mutual funds, and may be in only those schemes that focus on the primary market. This way, the investor will not have to do individual stock picking, where he is likely to go wrong, and at the same time he will get the benefits of a diversified portfolio, not dependent on the risks of 1 or 2 stocks, and the expertise of professional fund managers. In a mutual fund, the fund manager can replace some of the stocks which he thinks are not going to do well, so the lock-in does not become applicable to the scheme. However, the lock-in of 3 years may be mandated for the investor. Regrettably, the present structure of the scheme may actually work against mutual funds, which are the right medium for a small investor.
End Note: Equity is not a savings instrument, it is an investment option. A better name for this scheme may be India Retail Equity Participation Plan.
The author is Founder-Chairman & Managing Director, PRIME Database