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Tax break not worth direct stock play
March, 22nd 2012

The proposed Rajiv Gandhi Equity Savings Scheme is expected to come with safeguards that will permit small investors to purchase shares only in the top 100 stocks traded on Bombay Stock Exchange and the National Stock Exchange.

An exception is, however, expected to be made for public sector companies with the government expected to relax the rule to allow trading in stocks that are part of the top 500 list. The move is aimed at increasing retail participation in not just the stock market but also in disinvestment exercise.

However, market experts are not very enthused about the scheme, which will allow a 50% deduction for those who invest up to Rs 50,000 in stocks, provided their taxable income is below Rs 10 lakh.

The funds will not be allowed to be withdrawn for three years, even churning of portfolio is not permitted during the first year. The scheme can be availed only once in a lifetime.

Financial experts said the scheme may give tax deductions but investors could well end up with much lower gains even if investments are made in blue-chip companies.

Investments even in blue-chip stocks wouldn't bring enough gains for average retail investors if the past record is any indication.

Several blue-chips including almost the entire Reliance pack, Bharti Airtel, BHEL and NTPC have given lower returns than diversified equity mutual funds (MFs) and tax saver funds in the past three years (till March 19).

DLF was up 11.3% in three years, and NTPC declined 3.7% during the same period. Tax-saver MFs that come with a three-year lock-in period have gained 26.8% annually in three years while diversified equity funds gave 29% annual returns.

Several sensex stocks have gained at a lower pace than the index itself. The markets have been on a roller-coaster ride in the past three years. The sharp market rally after the general elections results were announced in 2009 was followed by sporadic periods of volatility. Sensex gained 24.2% a year in three years while Nifty gave annual returns of 23.2% during the same period.

"It would be much better if the government gets them (new investor) to invest in an index," said Suresh Sadagopan, founder, Ladder7 Financial Advisories.

Jayant Pai, head of marketing at Parag Parikh Financial Advisory Services, is of the same opinion. "If they restrict it (investments) to index stocks it would be good," Pai said.

"Details on it (RGESS) should be out in a month's time," finance secretary R S Gujral said on sidelines of a Fimeet on Tuesday.

The government can allow investors to participate in RGESS through exchange traded funds (ETFs), said experts. A separate ETF can be created for the scheme with either Nifty or BSE-100 as the underlying index. But even this can be no guarantee against losses or underperformance, said market observers.

"It (index) is a filter. But it is not foolproof and will not prevent investments from losing their value," said another expert. Unlike MFs, investments in stocks could completely lose the entire value. Stocks of leading companies had lost up to 90% in value in the market downturn during the global financial crisis.

With investments in equity-linked savings scheme (ELSS) - as tax-saver MFs are known - also eligible for tax deductions, investors wouldn't have enough money left to deploy in stocks, said experts. "ELSS is a better option than RGESS as MFs have a clear track record," Pai said.

The government has drawn upon the experience in Europe which had tried the model and increased retail participation in the 1970s. A similar scheme, with much higher cut-off, was first tried in France which was then used by Belgium, West Germany and Sweden.

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