Evergrande development has been called as China’s Lehman moment by some. Stock markets have been worried and this ensured there was a broad sell-off in US stocks post the Evergrande news. What is Evergrande? Why should you care? Evergrande is a troubled Chinese property developer Evergrande. It has been hit with multiple ratings downgrade in as many days. But fortunately, Indian stocks have successfully shrugged off the Evergrande concerns so far. But anything can happen in future. Thus, it is important to understand the issue at hand for equity investors, irrespective of whether they have exposure to Chinese stocks or not.Â
World’s most indebted company
Evergrande is China’s second largest real estate company by sales. All was going fine, until Covid hit. As the company now struggles to repay creditors, global markets have responded with selloffs. To put things in perspective, Evergrande debt is now over $305 billion. And, it borrowed from everyone! Contagion fears have intensified as 128 banking institutions and 121 non-banking institutions are exposed to Evergrande.
Questions loom about a government bailout and whether Evergrande is in fact too big to fail. With the company warning investors that it could default on its debts, ratings agency Fitch has said that default ‘appears probable’ while Moody’s has said ‘Evergrande is out of cash and time’.
Apart from Covid and slowing real estate sales, do bear in mind that Evergrande fall-out is a result of growing government regulation in China’s property sector. The government there has been increasingly working to control surging home prices and excessive borrowing.
Fall, rebound
Evergrande is likely to default unless it successfully negotiates a restructuring plan with banks. The company has also been unable to repay investors in the wealth management business. This is why many have called Evergrande as China’s Lehman moment.
After a crash on Monday, most stock markets in the world such as Sensex and Nifty rebounded slightly on Tuesday. But worries remain about the impact the default would have on the global economy. Recall how IL&FS defaults shook the core of BFSI industry in India in 2018. Hence, stock markets around the world continue to keep a close watch on the Evergrande crisis, because such developments can spiral out of control at any time.Â
Play safe
The truth is nobody really knows how the Evergrande and it’s 300 billion dollar debt mountain will play out.Â
In the event of a collapse, the Chinese economy and financial system will suffer a huge blow. Along with this, there will be a domino effect on several other domestic sectors and a spill-over effect on the global economy, especially financial institutions and businesses that are directly and indirectly linked to real estate and housing.
If you are wary of a risk-off situation, you should play it safe for a while. This means use asset allocation principles to decide exit and entries in equity, debt, gold, cash and mutual funds. Don’t try to venture out on adventures during the period when the Evergrande situation has no clarity.Â
Tag: Equity Markets
How to set off losses from share trading
The ongoing crash in stock prices is being prescribed as a chance to enter the market at moderately lower costs for the long haul. This point of view is being talked about broadly, however this piece is about a strategic opportunity to make good of your losses. This is tied in with setting off losses and taking the advantage thereof.
What are capital losses?
When you sell a capital asset for a price higher than its purchase price, it is a capital gain. When the money from the sale of a capital asset is less than cost of acquisition and expenses on transfer, it is a capital loss.
The rules
The Income Tax department does not allow loss under the head capital gains to be set off against any income that you might have earned under any of the other heads such as salary income or income from other sources. You can set this off only within the capital gains head. Note that shares and equity mutual funds are long term capital assets when held for more than 12 months.
The standard rule about set-off of losses says that the loss from the transfer of a short-term capital asset or Short Term Capital Loss (STCL) can be set off against gains from the transfer of either a long-term or short-term capital asset, that is, a Long Term Capital Gain (LTCG) or Short Term Capital Gain (STCG) in that year.
So, if you sell a stock or an equity-oriented mutual fund scheme (this includes only the growth option) within a year of buying it at a loss, you can set off that loss against LTCG or STCG from any capital asset. The other part of set-off is that the loss from transfer of a long-term capital asset or a Long-Term Capital Loss (LTCL) can be set off against gains from transfer of LTCG from any capital asset in that year.
For instance, if you had invested in debt-oriented mutual fund scheme and sold it within three years of holding, you can set off STCG against the STCL from equity. If you redeem the debt mutual fund after three years, it is considered as a long-term capital asset and the LTCG can be set off against the LTCL from equity.
Note that if you had purchased stocks or funds before January 31, 2018, things will be a bit different. This date is the ‘grandfathering date’ for equity prices. So, if you had purchased your funds before this date, the initial purchase price will not be considered. The price as on January 31, 2018 will be considered as the price for tax purposes.
Not able to set off losses, there is a solution for that too.
Carry forward of losses
If you are unable to set off your entire capital loss in the same year, you can carry losses forward. This includes both STCL and LTCL. You can carry forward these losses for 8 assessment years that immediately follow the assessment year in which you made the losses. If capital losses have arisen from a business, you are allowed to carry forward those losses. You can do that without running the business. Carrying on of this business is not compulsory.
Tax strategies
Not happy about selling those stocks or mutual funds? You can book the loss now and buy the stocks or mutual fund units and hold them for the long run. Also, if you are worried about booking profits to set off losses and paying taxes, here’s a solution. Equities being long-term investments, you will eventually sell them after five, ten or fifteen years. Since you are selling them now and buying them at a relatively lower price, you might have to pay more in taxes later as you will have more gains. Well, there is a solution for this. As you might know, up to Rs. 1 lakh of LTCG from equities is exempt from tax per financial year. Try and book capital gains of up to Rs. 1 lakh every year. Once you book profit, you can buy the stock or mutual fund unit to maintain your long-term investments. There is no limit on the amount you can set off or carry forward. However, the amount of LTCG you can book per year without tax is limited.
Mandatory info on capital losses
The Income Tax Department has made it mandatory that investors cannot carry forward losses for a year unless that year’s income tax return (ITR) has been filed by them before the due date. Even if it’s only the capital losses and you do not have any income to show that year, you will need to file your ITR.
How are index funds different from large-cap funds?
Over the last couple of years, there have been talks about how index funds are performing better than actively managed mutual funds. First, let us look at why some of the large cap funds are just not able to beat the benchmark index.
Index fund vs large cap fund
A few years back, the Securities Exchange Board of India (SEBI) recategorised mutual funds. Why? This was to make sure that different schemes launched by mutual fund houses are clearly distinct in terms of asset allocation, investment strategy etc. Further, this was to bring in uniformity in the characteristics of similar type of schemes launched by different fund houses. This was to help investors to evaluate the different options available before taking an informed decision to invest in a mutual fund.
After the categorisation of mutual funds, large-cap funds had to invest a minimum of 80% of their portfolio in the top 100 stocks as calculated based on the market capitalisation of the stocks. Due to this, large cap funds are struggling to beat the benchmark index that is available at a lower cost. Note that before the recategorisation, several large-cap funds could take exposure to mid- and small-cap stocks and this helped them generate higher returns.
Now, what are the differences between index funds and large cap funds?
Large cap funds are actively managed funds. Funds where the fund manager decides which companies to invest in based on their research are called actively managed funds. All large/mid/small cap funds are actively managed funds.
Index funds are passively managed funds. Funds that track or mimic the composition of an index are passively managed funds. The index could be Nifty 50, Nifty Midcap 100, BSE Small cap, etc. For example, an Index fund tracking Nifty 50 will invest in all the 50 companies on the Nifty.
So, in a large cap fund, the fund manager decides which stock or sector to invest in. An index fund just tracks the benchmark index. There is no market research or intelligence involved here.
Since market research skills are needed for large cap funds, these funds have higher expense ratio compared to index funds. The biggest advantage of an index fund over a large-cap fund is its low cost. Fund management cost of an index fund can be as low as 0.17% whereas large cap funds charge anywhere between 1.5% to 2.25% as fund management charges.
Then, come the fund performance. Note that if the large cap fund manager’s views are right, the fund will generate higher returns or will outperform the benchmark. However, if the views don’t turn out to be right, it can lead to lower returns or under performance. For index funds, the returns will mimic that of the index.
The volatility of the index funds is generally comparatively lower than that of large-cap funds.
Who should invest in large cap funds?
Investors with a low level of risk tolerance can consider large cap funds. Investors who belong to the elderly age group or those who are nearing retirement should consider adding large cap funds to their portfolio. Even those who are looking at income can consider large cap funds with a good dividend history. The steady flow of dividend acts as a stable source of income. Investors with a long investment horizon and looking to invest for long term goals could channel their investments towards large cap funds. When compared to mid-cap funds and small cap funds, large cap funds are less risky.
Who should choose index funds?
First time mutual fund investors can consider index funds. It is a good way of getting introduced to the market at lower costs and lower risks. Those investors who are nearing their age of retirement could consider Index funds. Investors with low risk profile and limited capital can try index funds.
What’s the buzz in the marketplace?
With several large cap fund managers mimicking the benchmark index, wealth managers and other financial experts feel investors can make large cap allocation using low cost index funds. In these, fund managers don’t hold on to cash and there is no fund manager bias.
There are others who are saying that if you are going for an actively managed fund it is best to choose multi cap funds rather than large cap funds. Why? This is because these funds have the flexibility to choose stocks across the large cap, mid cap and small cap categories. So, while risk-averse investors can choose index funds, those with a medium or high-risk appetite could consider focused funds as part of their large cap allocation. If you are not sure about which fund suits your risk profile, financial situation and life goals, get in touch with your consultant at wealthzi.com.
