Four fixed income options to consider these days

The recent 0.5-per cent rate cut by the Reserve Bank of India has brought some cheer to stock markets and people who are planning or are currently servicing home loans. On the other hand, people who are dependent on fixed income options like fixed deposits (FDs) are a worried lot as banks have swiftly reduced interest rates. In such a scenario, it would be worthwhile to consider if it's time to rejig one's debt portfolio.

OPTIONS TO CONSIDER

According to Murthy Nagarajan, head (fixed income) Quantum Mutual Fund, the interest rate course is clearly headed downward. "The instrument best placed to take advantage of the falling rates is a government securities (G-Sec) and Dynamic Bond Fund. Other than this, some of the other options that retail investors can consider include corporate FDs, income fund, fixed maturity plans, tax-free bonds and small saving schemes like PPF, Senior Citizens Saving Scheme, etc."

CORPORATE FIXED DEPOSITS

Corporate FDs continue to remain an attractive proposition as the interest rates of these instruments are at elevated levels. It is generally seen that the rates for these FDs are 0.5-1.5 per cent higher than the traditional bank FDs. However, with high return comes the risk that the company can default on its principal and interest payment. One has to be very mindful of this caveat while investing. The general rule to be followed while choosing the FD would be to invest in only those names which have a rating of AA or above.

SMALL SAVING SCHEMES

The rate of small saving schemes like PPF, Senior Citizens Saving Scheme and National Savings Certificates are generally linked to government bond yields of the same tenure. Since these rates are set only once a year, which is around March-April, there is still some time for investors to lock in their long-term savings in these instruments. Here, one has to take note of investment caps and tax benefits that can be availed in each of these instruments.

TAX-FREE BONDS

Even though a sharp spike in tax-free bonds was seen post the rate cut, experts are of the view that there is more room for gains here. As interest rates are heading south, gains from this instrument will be on rise. One has to be cognisant of the fact that new issuance which will be hitting the market will be priced lower than the previous ones. The current issue of Power Finance Corporation bonds is priced at 7.6 per cent (for 20 years) as compared to the recently closed NTPC bonds, which were offering 7.62 per cent for the same duration. The only catch point while investing in such instrument is that since these are long-duration investment spanning across 10-20 years, one has to be very mindful that they must be aligned to ones long term goals.

DEBT MUTUAL FUNDS

The recent rate cut has come as a huge boost to the debt market. Long-term bond funds like income and gilt medium and long-term funds have seen a sharp spike in returns since the last one week. But do these options still hold steam? Lakshmi Iyer, chief investment officer (debt) and head of products, Kotak Mutual Fund says, "Since we are in an environment where there is expectation of interest rates easing from current levels, we expect duration funds in the debt segment to do better compared to other debt category funds. The key is to have a horizon of above one year for this to play out."

The other option for any investor looking to eliminate interest rate risk could be a look at fixed maturity plans. These funds essentially buy assets maturing in line with the maturity of the fund and hence try to mitigate interest rate risks. Typically, if interest rates are expected to rise, the fund manager will invest in short-term securities that mature early and reinvest the proceeds at a higher rate.

Conversely, if interest rates are expected to fall in the future, the scheme would invest in long-term bonds to lock in current high interest rates. And if interest rates fall subsequently, the value of bond will increase providing capital growth.

From tax efficiency angle, while taking any decision in terms of investment in the above-mentioned options, remember that one has to hold on to these funds for, at least, three years to claim benefit under long term capital gain, according to the revised tax rules pertaining to debt funds.

(In association with Mail Today Bureau)