Life after LTFs

SET could see impact if popular tax-saving fund programme is allowed to expire, but extent would depend on how new investment vehicle is received. By Tisco Securities

The current long-term investment fund (LTF) programme, which has been operating for 14 years, has been responsible for creating 379 billion baht in assets under management. But the Federation of Thai Capital Market Organizations (Fetco) has proposed not renewing it after 2019, replacing it with a new investment vehicle. It is worth examining the potential impact on the Thai equity market if the scheme is allowed to expire.

We believe in the worst-case scenario, the expiration of the LTF programme would result in the SET index losing between 79 and 122 points per year based on the historical relationship between institutional selling and SET movement.

This would lead to the SET forward price/earnings ratio (P/E) contracting from an average of 14-15 times to less than 11 over a period of five years, or until the remaining LTF assets under management are depleted, estimated by 2025.

Fetco has proposed a new scheme designed to encourage lower-income people to participate by way of a tax credit (100,000 baht per year maximum per person) and a more extended lock-up period, which should alleviate the problem for the SET. However, we expect that there could be some transition pains in 2020 when the new scheme — if approved by the cabinet — takes effect.

Both LTFs and retirement mutual funds (RMFs) offer tax benefits for equity investors. LTFs were established in 2004 to promote long-term savings by allowing investors to deduct up to 15% of their total annual income or a maximum of 500,000 baht a year. Capital gains from the redemption of units are exempted from tax.

RMFs work in a similar manner. However, unlike LTFs, RMFs tend to be a mixture of equity and fixed-income funds, leaning towards the latter. As well, the lock-up period is much longer, as investments can only be redeemed when the unit holder reaches age 55 or after five years.

The amount of money going into LTFs and RMFs varies each year, but after adjusting for SET index movements, we estimate that LTFs have received around 18.8 billion baht a year of net inflows each year since 2010.

For RMFs, we estimate an average inflow of 10.9 billion baht a year. As a result, both LTFs and RMFs have been growing steadily and their rise coincides with local funds’ rapidly growing equity assets under management.

In the worst-case scenario, where LTFs

expire after 2019 without any substitute, we estimate the Thai equity market would be deprived of 18.8 billion baht in net inflows per year from LTF contributions (based on estimated inflows in 2016-17).

Furthermore, LTFs that have reached their term limit would end up being redeemed with no possibility of repurchasing.

While there is no official data on redemption rates, we estimate that redemption amounts should range within 55 billion and 96 billion baht between 2020 and 2025.

ARGUMENTS FOR EXPIRY

We see three reasons why the government could be reluctant to extend the LTF programme beyond 2019:

1. There’s a perception that under the current LTF structure, high-income earners save more tax than low-income earners because of the way the current tax deduction scheme works: the higher your tax bracket, the more tax you can deduct.

2. The LTF unitholder base is likely to be well under 1 million. As of June 2018, the Association of Investment Management Companies (AIMC) reported there were a little under 1.2 million LTF accounts, though many are held by the same individuals.

3. The original objectives of the LTF programme appear to have been accomplished. Assets under management by local funds have exceeded 8% of total SET market capitalisation in 2018.

Considering the LTF itself was a byproduct of the 1997 financial crisis, we believe

that instead of abolishing LTFs outright, a better solution would be to refresh the objectives of the programme so that it becomes more aligned with the country’s strategic goals over the next decade.

The core theme should shift from promoting the equity market to improving savings among the mid- to lower-middleincome group. This is of utmost importance considering that the average household savings rate is currently less than 10% on average after debt servicing.

At the same time, a larger portion of the proceeds from the new fund should be invested in stocks that are aligned with the government’s strategic directions.

USING TAX CREDITS

Fetco had proposed the use of tax credits at 20% of total money invested in the fund with up to 100,000 baht in tax savings for 500,000 baht or more investment in the fund. We believe this will enable all income groups to achieve the same tax savings rate compared with the older scheme.

Furthermore, at least 50% of the new fund’s assets will need to be invested in stocks that align with the government’s national agenda and master plan. These include, but are not limited to: Thailand Future Fund; other government-mandated infrastructure funds or stocks in the ESG (environmental, social and governance) sustainability investment list, which currently consists of 73 listed companies and include stocks in the large, mid- and smallcap segments. The idea is to encourage companies to join this list, which we think will ultimately benefit the capital market and the country.

Fetco’s proposal is similar to our argument for the use of both tax credits and tax deductions simultaneously as a way to equalise tax savings rates. We believe that ultimately this is a win-win outcome for all parties involved.

However, the government must make the creation of a new fund and the associated laws a priority given that the election is approaching, and the civil service apparatus may not function at full capacity once we enter the electoral campaigning and transition period.

Meanwhile, local mutual funds and the SET need to adapt to the new scheme and develop ways to encourage lower-income people to invest in order to ensure that the capital market continues to have a steady stream of cash inflows to offset the inevitable redemption from the expiring LTF scheme over the next seven years.

Instead of abolishing LTFs outright, a better solution would be to refresh the objectives of the programme so that it becomes more aligned with the country’s strategic goals over the next decade.