Don’t worry about the ‘equity cult’

Imagine you are planning a vacation. Which of the following options would you choose? Lounging in an armchair and downing hot pakoras at a luxury resort in Manali, or white-water rafting, rock-climbing and bungee-jumping at a remote outpost in Uttarakhand?

I would love the first, but not even wild horses could drag me to the second. But many readers may feel otherwise.

The decision to invest in equities is very similar to this. If you’ve got a stomach for risks and enjoy the big pay-offs that stocks can bring you, you will take to equity investing like a duck to water.

But if a small blip in your bank balance has you tossing and turning all night, no amount of incentives may make you cosy up to stocks.

As the newly minted government is deluged by demands to ‘revive the equity cult’, it should keep this analogy in mind. Instead of trying to coax reluctant retail investors into the stock market, it should go about this task the other way.

Enable India Inc to pull up its fundamentals by the bootstraps, purge the markets of dubious promoters and vanishing companies, and coax the really exciting businesses to list on the stock exchanges.

Then retail investors, the ones who would opt for the adventure camp, would automatically make a beeline for equities.

Increasing retail participation in the stock markets has been on top of the policy agenda for at least five years now, with the Centre as well as the market regulator coming up with many ideas to woo retail investors.

The initiatives have relied mainly on special quotas, discounts on shares and tax breaks to get small investors interested in equities, combined with many new measures to ‘protect’ these new debutants.

Therefore, to promote Initial Public Offers (IPOs), the Securities Exchange Board of India (SEBI) has tried out many ideas.

It has reserved 35 per cent in each offer for retail investors, mandated that IPOs raise half their money from institutions, ushered in anchor investors, initiated IPO grading and safety nets and asked merchant bankers to display their track records, all so that retail investors can have a safe passage. Why, it has even taken on the thankless task of poring over prospectuses to throw out the lemons.

Yet, all this hasn’t shaken the primary market out of its slumber. Retail investors, still nursing losses from their big bets on the previous crop of overpriced IPOs in 2008 and 2011, have largely stayed away even from quality issues.

On the other hand, faced with onerous rules and conditions to access the IPO market, large and successful enterprises have chosen to remain unlisted. Nascent businesses which are doubtful of filling the mandatory quotas in an IPO have instead tapped eager private equity investors.

No matter how many checks and balances SEBI may put in place to make IPOs safer for small investors, the unvarnished truth is that IPOs aren’t ‘safe’. Investing in an IPO is a wild card bet on an untried venture about which you have limited financial information.

The business can turn out to be the next Infosys; or it can flop because it was unable to compete with the Goliaths in the industry.

As IPOs are also about company founders wanting to sell their own stakes, world over, they are seldom priced at a bargain.

This is why cajoling a risk-averse investor into IPOs through quotas, discounts and safety nets is counter-productive.

Instead, if policymakers want the primary markets to thrive (and this is essential for corporate fund-raising), they should draw up plans to attract the best issuers to the market and allow savvy investors to bid for shares at the price they think is right for the business.

SEBI’s attempts to improve participation in the primary markets have at least helped to clean them up. Government-sponsored schemes to drive the equity cult have not served even this purpose.

Instead of educating investors about how stock markets work, how businesses are valued on it and what sets apart a good investment from a poor one, they have tried to lure first-time investors into equities mainly through tax breaks.

So, stock market investments have been given tax breaks not available to any other class of investments, even those meant for small savers.

Long-term capital gains from equities are completely exempted from tax. Short-term gains get taxed at a concessional 10 per cent rate.

For good measure, though everyone knows that equities do not pay off for periods of less than five years, the definition of ‘long-term’ has been shortened to one year.

Tax-saving equity funds and schemes such as the Rajiv Gandhi Equity Savings Scheme offer upfront tax concessions if only retail investors will commit funds.

These tax breaks create perverse incentives. A small investor who simply does not have the surplus or the appetite to invest in equities opens a Rajiv Gandhi account or invests in an equity-linked fund just to get the upfront tax breaks.

Pensioners who cannot stomach capital losses invest in equity funds just to pocket tax-free dividends. When an adverse turn in the market leads to a capital loss, investors realise that the ‘tax break’ is really quite meaningless.

If an investor is risk-averse, either because of his circumstances or his mindset, it is prudent not to coax him into taking on stock market risk just because policymakers would like to see a buoyant equity market and a thriving equity cult.

Attempts to forcibly revive the equity cult also ignore the role that market conditions play in driving investor sentiment.

The world over, retail investors buy stocks when markets are upbeat and they have had a good return experience. In India, such a return experience has been lacking until recently.

So as the Government sets out to repair all that is wrong with the economy and markets, one project it can safely put off is the one to increase retail participation in equities. It can instead devote its attention to reviving the economy and by extension, India Inc’s fundamentals.

Retail investors, those with the risk appetite, will automatically throng back to stock markets if they are convinced of its return potential.

Who knows, by securing a thumping majority and drawing in foreign investors in droves, maybe the BJP has already done its bit to revive the equity cult.

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