Posts Tagged india

Home loan tax deduction is/maybe no more

One of the best things that I like about the proposed new direct taxes code in India is the lack of home loan tax benefits. Without much delay, let us start cracking with the advantages of doing away with such stupid laws.

The following points, when taken together, prove that home loan tax breaks do no good to the country, or its common people. If anyone was served by such laws, it was the builders and the bankers. Let me demonstrate how.

1. Lower tax rates compensate for lack of home loan tax breaks. It is as if everyone is getting more than the full benefit of home loan tax break, without taking a home loan.

2. Leverage: Home loan tax breaks encourage taking home loan even if you can save (partially or fully) for buying the house. Or if buying a house is more trouble than it is worth for you because of the mobile nature of your job, so you prefer renting. Encouragement of loan taking leads to over-leveraged consumer behaviour, similar to the US sub-prime mortgage trouble. Read up on the dangers of over leveraging here and here. Since home loans are very long term loans, there is the added risk of interest rates rising a lot which can even double your EMI and thus break your back.

3. Lower housing prices: Removing tax breaks for home loans would bring down housing prices. It is the simple concept of demand and supply. Today, people select a house based on the (EMI – tax break) they can afford. When tax break is no more, they will select a house based on the EMI they can afford. This brings down the demand price. The lack of tax break will mainly affect the margins of builders. As we know, builders are no cuddly teddy bears who cannot take care of themselves. Between the white, black and all colors of money they earn, they can better take care of themselves than any of their buyers or employees.

This point is complicated, read carefully. The absolute amount of money in the hands of consumers is higher because of lower tax rates so real estate prices may not come down in absolute terms. But relative affordability of houses as compared to, say, cars/stocks/clothes/food/travel will increase because there is no tax deduction just for paying interest on a home loan.

Initially the builders will try to maintain the high margins by delaying projects and reducing the quality of buildings. So the buyers will have to remain cautious in buying newly built houses for a while and check the quality thoroughly before buying. But we need to do that anyway. See a video by a Unitech customer here.

Upto a few weeks ago, I had assumed that the Government will never be able to defy the powerful builders’ lobby and such tax breaks will remain forever as evils of Indian democracy. But my faith in Indian democracy has been restored to a small extent. The Government has at least proposed to do away with tax breaks for home loan. Well done ministers / babus / everyone involved. I think hon. Finance Minister Pranab Mukherjee should not get all the credit for this, as hon. former Finance Minister P. Chidambaram and team had started work on this code and it might be his legacy.

Dangers of this proposal:

1. The biggest danger is, of course, of the Government surrendering against the real estate lobby and re-introducing the stupid home loan tax deduction.

2. Since the builders have cash to burn and the power to wait out, people who want to buy a house in next few years might not get the full benefit of lower house prices. Hence they might have to make do with lower quality house than if they waited a few years for house prices to react to this news. Eventually, of course, no one can beat demand and supply.

3. Of course, the price of your house may be less now for the same reason: the buyer of your house will not get any tax break for taking a home loan to buy it. But I guess it is a very small price to pay for more affordable housing for everyone, including your future self and your kids.

Related post: Risk Analysis of investment: Real Estate vs Equity


Comments (9)

Efficient Market Hypothesis in India

Efficient market hypothesis says that stock markets are informationally efficient i.e. all publicly available information is already reflected in the stock prices. (Note that it is mostly illegal to use non-public information for getting advantage on the stock market.) Hence, no strategy can significantly beat the returns of the market (represented by indices) for a sustained time period. People, both professional and lay investor alike, make mammoth efforts in beating the markets, losing sleep over every movement of the market. The efficient market hypothesis, if true, would prove that all such effort is wasted and can at best equal the returns from passive index investing and at worst earn less returns than even the indices.

Studies to prove/disprove this hypothesis have mostly taken place in developed markets. Here, we analyze whether it holds true in Indian markets. Among the different types of people who try and beat the returns of stock market indices, a type that can be easily studied is mutual fund managers. This is because they have to necessarily provide information about their portfolios and their periodic returns due to SEBI guidelines. Mutual fund managers must beat the market indices to justify their high salaries and the expense ratios of mutual funds. It is believed that less than 15% , or 3%! of the mutual funds in the US beat the market indices, which is commonly used as an argument in favour of the efficient market hypothesis. Let us see how Indian mutual funds fare:

I will compare the long term returns of ALL equity diversified mutual funds and ELSS funds with a well known index. Funds for which such analysis is not possible will be discarded and reasons for doing so will be one of the following:

  1. Bonus issues by mutual funds: Date after last bonus issue will be considered. Bonus issues have gone out of fashion these days, so for most funds considered we can get such bonus free time periods of around a decade or so.
  2. Date of launch of the mutual fund: Only funds launched in the previous millennium (31 December 1999 or before) are considered so that we do not get dazzled by short term brilliance.
  3. Date of introduction of the index: In India, our indices are so young that we have mutual funds that are elder than Nifty by a decade or so. Still we can compare the performance of mutual funds against indices for a period of about a decade, so we will go ahead and compare with an existing index.
  4. Total returns: In regular indices, the dividends paid by the constituent companies of the index are not counted in returns. We have considered Nifty as the index for our purposes because its total returns index is readily available, which takes into account the dividend income as well. Since this data is only available 30 June 1999 onwards, mutual fund data of before this date has been discarded.
  5. Sector / Theme specific mutual funds will be discarded.

Following tables summarize our findings. The funds which have beaten Nifty are shown in green, those which lagged Nifty are shown in red. Data comes from Mutual Funds India. Returns have been considered starting from “Start date”, up to 15 July 2009 for the mutual fund as well as the Nifty total returns index.

Diversified Equity Schemes(all Growth/Cumulative option):

Scheme Name Start date Return from scheme (%) Returns from Nifty (Total Returns Index) %
BSL Equity 30/06/1999 1178.83 416.78
Tata Pure Equity 30/06/2000 472.47 332.77
Templeton India Growth 02/05/2000 651.73 367.63
HDFC Equity 30/06/1999 1316.3 416.78
Franklin India Prima Plus 30/06/1999 1070.69 416.78
Taurus Starshare 30/06/1999 598.16 416.78
Franklin India Bluechip 24/03/2000 523.58 314.09
HDFC Top 200 27/03/2000 518.97 315.41
Reliance Growth 30/06/1999 1766.29 416.78
LIC MF Equity 30/06/1999 225.91 416.78
Franklin India Prima 30/06/1999 1143.69 416.78
HDFC Capital Builder 30/06/1999 584.77 416.78
Tata Growth 14/07/1999 718.47 370.52
LIC MF Growth 30/06/1999 247.52 416.78
Taurus Discovery 14/07/1999 249.45 370.52
JM Equity 30/06/1999 283.31 416.78
BSL Advantage 23/03/2000 168.94 317.35
Reliance Vision 30/06/1999 1350.91 416.78
ICICI Prudential Growth 30/06/1999 695.17 416.78
ING Core Equity 30/06/1999 272.1 416.78
BSL MNC 28/12/1999 312.36 343.92
Sundaram BNP Paribas Growth Reg 16/05/2000 496.67 375.03

Equity Linked Savings Schemes(all Growth/Cumulative option):

Scheme Name Start date Return from scheme (%) Returns from Nifty (Total Returns Index) %

HDFC Taxsaver




LIC MF Tax Plan




Franklin India Tax Shield




ICICI Prudential Taxplan




These findings deal a fatal blow to the efficient market theory. Not only do about 70% of the mutual funds beat the market, many of them do so by a factor of 2 or more. Reliance Growth beat the market in this period by more than 400%. Note that the index returns considered are directly from the index and not from any index fund. If an index fund is used for investment, there will be some expense ratio of the fund and hence the index returns will be even lower than mentioned above.

This article is not intended to advertize mutual funds. Nor am I saying that mutual funds will necessarily continue beating the market by a wide margin. I have only analyzed the available data and come to the conclusion that Indian markets have not been demonstrably informationally efficient over the last decade. Hence stock picking has a lot of value in India. All the lost sleep over your stocks was not in vain, after all :).

Limitations of the above comparison:

  1. The comparison suffers from a survivorship bias. Which is to say, the funds which were performing very poorly were discontinued long ago and hence they do not appear in this study. Though in my defence, we have not seen a huge number of mutual fund schemes being discontinued, so possibly the bias does not invalidate my conclusions. In the US, only 15% or 3% funds beat the index even after a survivorship bias.
  2. A decade is not enough to get meaningful conclusions about long term trends. Here my defence is stronger. Efficient market hypothesis categorically denies the possibility of any strategy being capable of beating the market. As such, the onus is on the propounders of the hypothesis to prove that it is so. As market indices in India are very young, supporters of efficient market hypothesis also do not have enough data to be able to prove the hypothesis beyond reasonable doubt. All I claim is, the short term data that we have does not support the efficient market hypothesis.
  3. Maybe, NOW the markets are efficient and going forward it might get difficult to beat the market indices. Agreed. We can only say that so far there is no support for efficient market hypothesis in India. If you are reading this in year 2100 or more, maybe you can throw some light on this matter in the comments section.

Other problems with index funds in India:

  1. High tracking errors: Tracking errors as high as 10% are not unheard of, and fund managers have the audacity to justify the tracking errors. This proves that the index funds were started just to jump on the bandwagon but in essence many of the index funds are being actively managed.
  2. High expense ratios: Most index funds charge an expense ratio of about 1 – 1.5% which is outrageous. The exception is in ETFs (exchange traded funds) which charge around 0.5%. But even this is too high as there is not much that the fund manager has to do with an index fund and a lot of it can be automated by the fund house. Main reason to invest in an index fund is the low costs. In the developed markets, less than 0.25% expense ratio is charged for index funds. Hopefully as more money gets invested into index funds, fund houses will get a better economy of scale and expense ratios will come down.
    Chicken and egg: Index funds in India are not a good idea, partly because of high expense ratios, and expense ratios are high partly because not many invest in index funds because index funds are not a good idea.



More support about passive investing from developed markets:

Comments (3)