As tax trebles, investors flee structured segment
Investments in non-capital-protected structured products have fallen two-thirds, following a recent Sebi rule on their listing, which has inflated tax on returns from 10% to 30%.
A high rate of taxation is driving risk-chasers away from a popular class of derivatives known as non-capital-protected structured products.
In India, investments in structured products grew 21% in 2011 to `21,267 crore, according to the annual India Wealth Report of Karvy Private Wealth published in December 2011. Of these, the risk-laden, returns-rich non-capital-protected structured products account for some 10%. But investments in this segment have fallen almost two-thirds in recent times, according to one estimate.
If rewards that may come from investors’ risk-taking ability are neutralised by high taxation on returns, then it is inevitable that investors would shy away from such products, to protect themselves from any potential downside, bemoan industry sources.
In September 2011, market regular Sebi tightened regulations relating to non-capital-protected structured products. It ruled that such risky products cannot be listed any more. The new rules, market players say, have exposed investors to higher taxes.
Gaurav Arora, vice-president, products, IIFL Private Wealth, says that non-capital-protected products have lost out, following the new Sebi rules. “These unprotected products would be now taxed as per the applicable tax bracket, which for most clients would be up to 30%, up to three years. Earlier, they were taxed at 30% only up to a year and 10% thereafter, since the securities were listed then.”
Typically, structured products funnel the investor’s capital to both debt and equity markets. In the latter case, a basket of stocks or an index is used as a means. Returns on investments in debt instruments generally protect the portion of investment in equities. And any upside from the investment in equities is virtually a bonus.
For example, from a total investment of `100, `80 would be invested in debt instruments and `20 in equities. The `80 debt-linked investment is designed to generate a return of `20 which, in turn, would offset any losses from the `20 investment in equities. And any gains from the `20 invested in equities would add to the final payout, giving investors a higher upside than what debt-only investment would entail.
In non-capital-protected products, however, a greater portion of investment is directed toward riskier equities, which promises higher returns but also exposes investors to downsides, if equities don’t behave as expected. The lower investment in debt could reduce the final payout in such cases to amounts lower than the initial investment. In other words, there would be no adequate protection for capital invested in equities either.
One consequence of the new Sebi rules is that not just investments, even supply of unprotected products has shrunken to a trickle, says Rajesh Saluja, chief executive, ASK Wealth Advisors. “There are not too many people launching these products.”
Typically, high net worth individuals (HNIs) seek out unprotected products like equity-linked debentures, or are sought out by product distributors, including wealth managers. These products are usually issued by entities such as Karvy, Kotak, Citigroup, Deutsche Bank and Barclays, say market sources. Foreign entities in particular were active in the unprotected segment, says a source.
In September 2010, Sebi had asked ratings agencies to re-examine their methodology of rating such unprotected products. In response, agencies stopped rating such products altogether. One year later, Sebi issued a circular barring listing of new unprotected products (though those that were already listed prior to the circular remain unaffected).
Market sources fear an effective death-knell has been sounded for the unprotected product segment in India at a time when it is sinking its roots deeper elsewhere. For instance, in the US, more than half of the structured products are unprotected.
Despite the Sebi crackdown, other (capital-protected) structured products are still well-regarded, according to Saluja of ASK. “They are fairly popular. The ones in which principal (or the initial investment) is protected, is the domain of aggressive investors.”
Investments in non-capital-protected structured products have fallen two-thirds, following a recent Sebi rule on their listing, which has inflated tax on returns from 10% to 30%.
A high rate of taxation is driving risk-chasers away from a popular class of derivatives known as non-capital-protected structured products.
In India, investments in structured products grew 21% in 2011 to `21,267 crore, according to the annual India Wealth Report of Karvy Private Wealth published in December 2011. Of these, the risk-laden, returns-rich non-capital-protected structured products account for some 10%. But investments in this segment have fallen almost two-thirds in recent times, according to one estimate.
If rewards that may come from investors’ risk-taking ability are neutralised by high taxation on returns, then it is inevitable that investors would shy away from such products, to protect themselves from any potential downside, bemoan industry sources.
In September 2011, market regular Sebi tightened regulations relating to non-capital-protected structured products. It ruled that such risky products cannot be listed any more. The new rules, market players say, have exposed investors to higher taxes.
Gaurav Arora, vice-president, products, IIFL Private Wealth, says that non-capital-protected products have lost out, following the new Sebi rules. “These unprotected products would be now taxed as per the applicable tax bracket, which for most clients would be up to 30%, up to three years. Earlier, they were taxed at 30% only up to a year and 10% thereafter, since the securities were listed then.”
Typically, structured products funnel the investor’s capital to both debt and equity markets. In the latter case, a basket of stocks or an index is used as a means. Returns on investments in debt instruments generally protect the portion of investment in equities. And any upside from the investment in equities is virtually a bonus.
For example, from a total investment of `100, `80 would be invested in debt instruments and `20 in equities. The `80 debt-linked investment is designed to generate a return of `20 which, in turn, would offset any losses from the `20 investment in equities. And any gains from the `20 invested in equities would add to the final payout, giving investors a higher upside than what debt-only investment would entail.
In non-capital-protected products, however, a greater portion of investment is directed toward riskier equities, which promises higher returns but also exposes investors to downsides, if equities don’t behave as expected. The lower investment in debt could reduce the final payout in such cases to amounts lower than the initial investment. In other words, there would be no adequate protection for capital invested in equities either.
One consequence of the new Sebi rules is that not just investments, even supply of unprotected products has shrunken to a trickle, says Rajesh Saluja, chief executive, ASK Wealth Advisors. “There are not too many people launching these products.”
Typically, high net worth individuals (HNIs) seek out unprotected products like equity-linked debentures, or are sought out by product distributors, including wealth managers. These products are usually issued by entities such as Karvy, Kotak, Citigroup, Deutsche Bank and Barclays, say market sources. Foreign entities in particular were active in the unprotected segment, says a source.
In September 2010, Sebi had asked ratings agencies to re-examine their methodology of rating such unprotected products. In response, agencies stopped rating such products altogether. One year later, Sebi issued a circular barring listing of new unprotected products (though those that were already listed prior to the circular remain unaffected).
Market sources fear an effective death-knell has been sounded for the unprotected product segment in India at a time when it is sinking its roots deeper elsewhere. For instance, in the US, more than half of the structured products are unprotected.
Despite the Sebi crackdown, other (capital-protected) structured products are still well-regarded, according to Saluja of ASK. “They are fairly popular. The ones in which principal (or the initial investment) is protected, is the domain of aggressive investors.”
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