Institutional Memory

An interesting piece by Arun maira a former member of planning commission on Institutional memory in mint. Whenever I come across some good policy being implemented by some IAS officer or some politician in some part of the country I wonder why this can’t be replicated in the rest of the country. This article has put my thoughts into words which I have not been able to do – Poor institutional memory!


Algo trading and delisting of illiquid stocks

According to this article SEBI is planning to delist several illiquid stocks(4200) from the Indian stock market. India has a large number of stocks listed in the stock exchanges but almost no trading ever happens in quite a lot of them. And some of these stock are used for illegal transactions. I think this is welcome move from SEBI.  the article has also mentioned that SEBI is planning to bring new regulation in Algo-trading which is also a need of the hour in India.

Entry Fee of Funds in UK

This article in financial times talks about fund are using entry load fee to exploit naive investors and also how UK regulator is looking into the issue. As the article has noted India is ahead of Europe in this issue. Indian regulator SEBI has banned entry load of mutual funds in 2009. I have mentioned this fact in my blog earlier here.

An interesting difference I found in this article between India and UK is that Indian investors are charged less if they directly buy from the fund (direct option) while it is reverse in UK. This doesn’t make sense because if the investor directly approaches the asset management company(AMC),  AMC doesn’t have to pay any amount to the intermediary and they should pass on this benefits to the investor. But it seems European AMCs prefer having investors coming through regular channels.

I think I am missing something in the whole issue. The article does note that the investors directly approaching the AMC will increase costs over the regular channels like exchange but I am still not convinced that the costs increase to that extent. because of the cost structure the investors who are approaching the AMC directly can be considered as naive investors. This is exactly opposite in India. Investors directly investing with the fund management company are considered intelligent!! In fact SEBI has been bringing several new regulations into effect to ensure that investors directly approach AMC rather than regular channels.

Race, Gender and Job Market

Here is another article in Financial times on race, gender and Job market dynamics. I have written on this issue in this blog here and here.

This article talks about how some institutions are moving towards color/race blind. This means bye-bye to affirmative actions in universities etc. However on the other hand we have people with this opinion

“Ms Hobson believes “we cannot afford to be colour blind”. “We have to be colour brave,” she said in a Ted Talk. “We have to be willing, as teachers and parents and entrepreneurs and scientists . . . to have proactive conversations about race with honesty and understanding and courage.””

“Despite their preference for a multicultural approach, the two academics expect colour-blindness to gain in acceptance, not because people with ethnic minority backgrounds feel victimised by labels, but because white people do.

In a 2011 survey they found that the average white American believes they face more racial bias than African Americans.”

The last line applies even in India where upper caste people feel victimized by the reservations for lower caste people.

P.S Please do check out the full financial times article its very interesting.

NSE controversy – Part 2

This article on mint talks about the response of NSE on allegations about which I have written in this blog here. NSE in its response has completely refuted all allegations against it that it favored few brokers over others.

““NSE’s response is rather comprehensive; they have refuted allegations of collusion. They have highlighted that they did not violate any regulations that were prevalent during the relevant period. The exchange has also spoken about certain factual inaccuracies in report and sought fresh examination of the issue,” said the second person, he too declined to be named considering the sensitivity of the issue.

The allegations against NSE pertain to members who co-locate their servers on the premises of the exchange. Even at these co-located centres, some of the servers themselves might have differing hardware capabilities or workloads.

This issue first came to light when a whistleblower who went by the pseudonym Ken Fong wrote to the regulator alleging that NSE’s systems were being misused, and that some people consistently enjoyed advantages to the detriment of others. The minutes of Sebi’s technical advisory committee said that it had received three such letters from the whistleblower.

After examining the issue, a Sebi panel had recommended action for lapses on the part of NSE and exploitations made by brokerage OPG Securities under the guidance of the panel. The panel further advised Sebi that it may constitute a team comprising people with appropriate background to investigate the collusion aspect between NSE officials and OPG.

The report in question was prepared by a sub-committee constituted by TAC. This sub-committee had six Sebi officials and Om Damani, a professor of computer science and engineering at the Indian Institute of Technology, Bombay. In its report, the sub-committee said the bourse had not provided adequate details to the committee examining the issue.

NSE in the reply has stated that allegation that the bourse had violated norms by allowing non-ISPs such as Sampark (Infotainment) to lay dark fibre on its premises for various members is factually incorrect, said the second person cited above. ISPs refer to Internet service providers. According to NSE, Sampark was a sub-vendor of a registered ISP, the second person said.

Dark fibre refers to a dedicated communication line through which data travels faster than regular lines because of the absence of other traffic. As such, there is nothing illegal about using such faster connectivity infrastructure.

NSE, in its response, has also pointed out there were no clear regulations at the time of alleged violations. Between 2011-2014 the period, when certain brokers allegedly gained unfair advantage, there was an absence of regulations and tools that are currently being used to allow for fair access to market data and exchange platform, NSE has highlighted, said the second person.”

I think the words by people interviewed in the are rather carefully chosen. NSE may not have violated the regulations at that point in time but that does not necessarily mean they have acted in an immoral way. Regulations more often than not lag markets. Even in the present case India is still developing its regulations with respect to algo and high frequency trading. However lack of regulations does not mean that NSE is not responsible.

“The first responsibility of an exchange is fair access of the order book to all investors, if that is being violated then it puts question mark on the integrity of the exchange. The justification that there were no regulations during the relevant period is immaterial as the first principle that is fair access has been violated,” said Shriram Subramanian, founder and managing director, InGovernResearch Services Pvt. Ltd.

Sebi’s technical advisory committee had suggested that a framework should be established within Sebi and stock exchanges to detect any abuse of the system by algo traders.

According to a 17 May Mint report, Sebi has already started implementing the recommendations of the panel which advises it on algo trades. In consultation with Sebi’s technical advisory committee earlier this month, the regulator has decided to have more checks and surveillance at the level of exchanges. To ensure this, NSE and BSE Ltd could be asked to constitute a separate team to keep an eye on algo trades, Mint reported. These checks would be in addition to the existing surveillance systems of exchanges.


Wash sale in Mutual funds

An old article in Forbes on Wash sales in mutual funds. In US you cannot claim a short term loss on a security if you buy the security within +/- 30 days of selling the security. This article explains this concept and how to overcome it. As far as India is concerned I haven’t come across any such rule. Though in India if you buy a mutual fund just before ex-dividend date and sell it immediately afterwards then you cannot claim capital loss on it. This is to ensure that investors do not use this mechanism to avoid taxes on their capital gains as dividends of equity mutual funds do not attract tax.

Taxation of Mutual funds

Investment Company Institute (ICI) has a very good FAQ section on taxation of Mutual funds. Especially the last question on how timing of buying mutual funds can affect the amount of taxes one pays. Essentially what it says is that the distribution of returns by the funds affects the timing of taxes you pay but the amount of tax one pays is not affected by when you buy or when the profits are distributed. In a world where there is no concept of time value of money, timing of distribution of profits by MFs do not affect your profits otherwise they might.

“Is it true that mutual fund shareholders have to pay “someone else’s taxes” if they buy fund shares at a certain time? 

No—fund shareholders do not pay someone else’s taxes. Every fund shareholder is taxed only on his or her own economic income over the life of the investment.

Shareholders purchase and sell a fund at the fund’s net asset value (NAV), which is calculated daily. A fund accumulates realized and unrealized capital gains, interest, and dividends until it makes distributions. These gains and income increase the fund’s NAV until they are distributed. A fund distribution reduces the fund’s NAV; thus, amounts that are distributed reduce the gain (or increase the loss) that a shareholder realizes when fund shares later are sold.

Assume an investor purchases fund shares on Monday for $10 per share. The fund distributes a $1 capital gains dividend (attributable to previously realized gains accrued in the fund’s NAV) on Tuesday. The $1 distribution reduces the fund’s NAV to $9. If the investor sells the fund shares on Wednesday for $9, the investor will have no gain or loss.

  • No economic gain or loss: The investor purchased the fund for $10, and received a $1 distribution and $9 upon the sale of the shares. Thus, the investor paid $10 and received $10, for no net gain or loss. 
  • No taxable gain or loss: The $1 of capital gains distributed (on which tax would be due) is offset fully by the $1 loss realized when the shares purchased for $10 are sold for $9. Thus, the investor has no taxable gain or loss.

For a more detailed illustration, consider the following two scenarios:

Scenario 1: Assume that Investor A bought 100 shares of a fund for $10 a share. The shares rose in value to $20. Investor A then sells her shares, and owes taxes on $1,000—the capital gain of $10 a share times 100 shares. Investor B buys 100 shares at the fund’s new NAV of $20 a share, which includes the embedded gains. If the shares rise to $30 a share, and Investor B sells his shares, he would owe taxes on $1,000—the capital gain of $10 a share, times 100 shares. In other words, Investor A owes taxes on the $10 gain accrued while she owned the fund, and Investor B owes taxes on the $10 gain accrued while he is invested. Each shareholder is paying for his or her own gains earned.

Scenario 2: Now assume this same set of transactions occurs, except that the fund distributes its $10 accrued gain on the day after Investor B bought his shares at $20. Investor A still owes taxes on $1,000—the $10 gain on her shares, bought at $10 and sold at $20, times 100 shares. Investor B must now pay taxes on $1,000—the $10 per-share distribution, times 100 shares. The distribution reduces the fund’s NAV to $10. If Investor B pays the taxes from other assets and reinvests the full amount of the $1,000 distribution, he will now own 200 shares. The first 100 shares were purchased at $20 a share, while the second 100 were purchased at $10 a share. Investor B’s average cost basis for tax purposes is $15 a share.

The shares then rise by 50 percent, as in Scenario 1, to a new value of $15 a share. When investor B sells his 200 shares at $15 a share, for tax purposes he is treated as having purchased all those shares at his average cost basis of $15 per share. Thus, he has no new tax liability because he has already paid taxes on his own gain.

Is Investor B paying Investor A’s taxes when he pays taxes on the $1,000 distribution? No. Investor A paid her own taxes on the $1,000 gain when she sold shares at $20 with a cost basis of $10; she delayed paying taxes until she sold. Investor B paid taxes on the $1,000 distribution up front, but owed no additional taxes when he sold his shares with the same price ($15) as his cost basis. Thus, he pays taxes only on the $1,000 that he earned while he owned the shares.

Compared to other forms of investments, the only issue with a mutual fund is the timing of the taxes paid, not the amount of taxes paid. Taxes may be paid sooner (if gains accrued before purchase are realized and distributed) or later (if losses accrued before purchase offset realized gains), but total taxes paid will be the same.”

Here is another article in Forbes on taxation of mutual funds. In India the tax rules are very simple.The amount of taxes an individual pays is only dependent on amount of time he invests his money in the fund and not on the amount of time the fund holds its assets. This article and this article explain the taxes one has to pay at individual level in India. However this means people can game the system. If I have a strategy which entails high turnover it would make sense for me to float a mutual fund and invest the my money through mutual fund. This way I will avoid short term capital gains tax and pay long term capital gains tax  which is generally less than the former.