Alpha and beta may seem like Greek to the ordinary investor but these are crucial indicators of the risks and rewards of an investment. While beta is an indicator of risk, alpha is an indicator of an investment’s risk-adjusted returns. It tells us how much excess return the investment generated above its expected return.
Right now, stock investments carry a high risk because markets are close to their all-time high. Some analysts expect a correction, others predict a moderate rise, while a small minority thinks the bull run will never end. But most agree that even in the best case scenario, the Sensex should rise by about 12-15% in a year’s time. That means, you can expect your equity portfolio to gain about 12-15%.
Is that acceptable? It was, four years ago. When the interest rate on risk-free deposits was 5-6%, investors were content with a 15-20% return from equities. But interest rates on risk-free deposits have climbed to about 10% now.
So, given the risk they are taking by investing in stocks, investors expect at least 30-40% gains from their equity holdings. Anything less than that would not justify the risk they are taking. And it is quite a big risk, with a possible downside of about 15-20%.
If investors are not comfortable with the high risk that is inherent to equity investments, they should move to the safety of debt. “Fixed deposits are a good option for investors who are uncomfortable that their portfolios are skewing towards equity,” says K. Harihar, head of treasury, Development Credit Bank.
Right now, banks are offering very attractive interest rates on fixed deposits of tenures varying from six months to five years. Public-sector banks, which are perceived to be safer than their private sector counterparts by many investors, are offering up to 10% interest on deposits for up to one year. If you are a senior citizen, you get up to 0.5-1% more. The icing on this mouth-watering cake is that bank fixed deposits are completely risk free.
Experts believe that interest rates may rise marginally before inflation gets contained and the RBI eases its anti-inflationary measures. That would cause interest rates to make a U-turn. If you can afford to lock in your money for a few years, opt for five-year fixed deposit.
What’s more, this investment will be eligible for tax benefits under Section 80C. But there is a small risk in this long-term strategy: what if interest rates rise to 12-13%? Your investment would be locked in at 10% and the only option would be to sit back and calculate your notional loss.
Short- and medium-term fixed deposits, ranging from 199 days to 500 days, also carry this interest rate risk—what if rates fall to 7-8% by next year? You would have lost a golden opportunity to lock in at a high rate of interest. A good way out is to have a mix of short-, mediumand long-term fixed deposits in your portfolio. Just keep revolving the investments as they mature. The mix of deposits of different maturities evens out the interest rate risk and optimises your returns.
Though fixed deposits offer assured returns, there is one major drawback. The interest earned on the deposits is added to the income of the investor and taxed accordingly. In the 30% tax bracket, the posttax yield from a fixed deposit of 10% gets pared down to 6.7%. Look at other tax efficient instruments like FMPs and liquid funds as well to make the most of the current opportunity.
FMPs are closed-ended mutual fund schemes that invest in fixed income instruments and usually offer returns that are equal to the prevailing interest rate. So, why should anybody prefer them over FDs? That’s because the income from an FMP is treated as capital gains. If the holding period is over a year, the income is long-term capital gains and taxed at a lower rate of 10%. These long-term capital gains are also eligible for indexation benefits which reduces the tax significantly. For maximum tax benefits invest in an FMP with a tenure of at least 13 months. However, if an FMP is redeemed before maturity, there is an exit load.
Still, they are the hottest new debt option in the market. “It would be a good strategy to exit some stocks and get into FMPs,” says Prateek Agarwal, head equities, ABN Amro Mutual Fund. He says the money could be redeployed in the markets if and when there is a correction. In FMPs too investors could adopt a multi-maturity strategy and invest in a mix of tenures.
There are other debt mutual funds options. Liquid funds, for instance, are an ideal destination for those looking for an ultra-safe avenue to park a huge sum (such as the sale proceeds of a real estate transaction) for a short term. These funds invest in the short-term money market (like lending to banks and corporates for 10-15 days) and the principal is completely safe. There is no entry or exit load and the liquidity is very high. You get the redeemed amount in your bank account within a day or two.
Fixed income options are a good way of rebalancing an equity-domiated portfolio. This is necessary because the unprecedented growth of equities in the past four years has bloated up the equity portion of many portfolios. Balanced investors who began with a 50:50 allocation to debt and equity about two or three years ago now have about 90% of their assets in equities. Willy nilly, many investors have changed from conservative to aggressive.
How Iyer did it
Bangalore-based Anantharaman S. Iyer is perfect with his timing when it comes to investments. Only, it is fixed income instruments he has been investing in, not stocks and shares.
Eight years ago, Iyer exited the stock markets because he wanted to create a steady stream of income post-retirement. His choice: the Monthly Income Scheme (MIS) of the Post Office which gave 8% returns.
“At my age, it was difficult to track the markets. I moved into mutual funds and fixed income,” he says. But fixed income does not mean a fixed mindset. Iyer has constantly been on the lookout for a better deal.
Three years later, the Government’s Senior Citizens Savings Scheme came as a godsend. The nine per cent returns seemed too good to be true at a time when interest rates were drifting downwards.
Iyer exited funds and invested in the assured returns scheme. Now that the interest rate cycle is on an uptrend, Iyer is once again scouting for opportunities.
“The interest rate offered to senior citizens can be up to 10.5%,” he chuckles. Iyer has already shifted a chunk of his investments in the Post Office MIS and the Senior Citizen’s Scheme to bank fixed deposits.And he is very clear about his future plans. If interest rates have climbed down by the time his fixed deposits mature, he will shift his investments back to the Senior Citizens’ Scheme.
