One very controversial aspect of IPL this year has been the ‘Impact Player’ rule that was introduced in the 2023 season. The Impact Player in the IPL allows each team to use one substitute who can actively bat or bowl in the match.
The Impact Player rule lets top-order batsmen take high-risk, high-reward approach, knowing a substitute can step in if needed.
This rule has fundamentally changed teams’ strategies with the 200 run mark being breached frequently. Case in point – The run rate has reached an all-time high from 8.80 in 2022 to 9.42 in 2024!
Rules such as the the Impact Player significantly influence gameplay strategy. Similarly investment rules andtheir associated incentives shape our investment strategies. Let me explain with another cricket analogy.
Let’s assume that every run scored is treated as income for the batting team, which is then taxed. Also assume that each run scored would be taxed at the same tax rate, i.e., 20%, whether it is a 1, 2, or a boundary (4 or 6). With uniform tax rates for both the batter and the team, the source of runs becomes inconsequential.
But what if a differential tax rate was introduced – say 30% tax rate for 1s & 2s and 10% tax rate for boundaries i.e. 4s & 6s. Let’s see what could be the impact:
- Batters would prioritise hitting boundaries to minimise tax burden and maximise post-tax runs.
- Batters would start taking more risk as they increasingly look to hit big shots.
- There would be more dot balls as batters have less incentive to run between the wickets.
- The rule would discourage all-round play, impacting players who excel in building long innings, and encourage players who can hit only the big shots.
How does this tie-up with investing?
Taxation is a major determinant of how we invest our funds. Currently, equity investments through stocks & MFs are taxed at 10% (LTCG) and 15% (STCG) whereas Debt investments (FDs, bonds, debt MFs) get taxed at your slab rate, which can go beyond 30%.
Due to the pronounced imbalance in tax rates, investors tend to allocate a significantly larger proportion of their portfolios to equities than they would under more equitable tax conditions.
If there are two options to invest—Nifty 50, which may give ~13% return with significant volatility (Nifty 50 TRI [Total Return Index] has given a return of 13.4% on a 10-year annualized basis), or a corporate bond offering a 12% return without any volatility—most investors would prefer investing in Nifty. This is because its post-tax returns would be 11.7% compared to 8.4% for the bond.
The difference between the returns is a whopping 3.3%!
But if both these options were taxed at 20%, the post tax returns for Nifty would be 10.4% and for the bond would be 9.6%. The difference between the returns is now just 0.8%.
In such a case, many investors would start increasing their allocation to debt & reduce their overall portfolio risk.
Why am I discussing this topic now?
Recently, there were some murmurs (or rumours) of tax rationalisation bringing taxation of all asset classes at par. Should this materialise, it would represent a significant shift in asset allocation, particularly benefiting debt as an asset class. Consequently, allocations to debt within portfolios would likely see a substantial increase and the portfolios would be less affected by market volatility.
Let me know your thoughts on this topic.
Till the next time,
Vijay
