One up on Bond Street
Nitya Varadarajan August 18, 2008
It’s no surprise that investors often turn to the bond market when interest rates are high. But debt funds (that invest in gilts) are not a good idea just yet—there are other attractive options. Interest rates are still volatile, and most bond market experts feel that rates could stabilise around September-October. It is always better to tap debt funds after rates have stabilised or are heading downwards.Even though the 10-year benchmark G-sec yield is hovering around 8.89 per cent, down from 9.05 per cent on July 10, 2008, experts feel that the rate is not sustainable and will move up, given that Treasury bills (the rate of return for one year) are giving much higher yields at 9.43 per cent. Says Ashish Nigam, Head, Fixed Income, Religare Aegon Asset Management: “With inflation ruling high (12.44 per cent for the week ended August 2, 2008), the 10-year coupon rate is unsustainable and is bound to go up after another repo rate hike.” If you are looking for opportunities in the debt market, then have a game plan ready for the next twothree months. Says Mallinath Madineni, CIO, Arthamoney, a personal finance company targeting retail investors: “It is a good time to start looking at debt investments, but don’t rush to invest in debt.”
There are plenty of options in the debt universe apart from bank fixed deposits, though some, like Oriental Bank of Commerce, have already started offering 11 per cent interest. Fixed maturity products, the shorter duration liquid funds and even floater funds can offer decent returns. Look at the various scenarios before investing.
Lock-in or not?
In the debt universe, Post Office fixed income products with fixed terms, perhaps, don’t make the cut. The Kisan Vikas Patra and National Savings Certificates have a long lock-in periods. Investors have to hold these investments for 5-6 years, at an interest rate of just 8 per cent, which rules them out as options. Even the Public Provident Fund’s 8 per cent return is not too high, but since it’s tax-free income, this debt scheme still manages to pass the muster.Lately, banks have been increasing the interest rates on deposits. But the rate varies depending on the maturity period. Deposits that mature within a year fetch higher returns of around 10.5 to 11 per cent, while long-tenure deposits yield a lower rate. The disadvantage for investors is that bank interest are taxed. Individuals in the higher tax bracket may see their post-tax yields reduce considerably. At the 30 per cent tax bracket, a 10.5 per cent bank deposit manages to eke out a post-tax return of just 7 per cent. So, you may want to avoid this product. But it’s a green signal for fixed maturity products (FMPs) even though these are fixed-term products with a lock-in like a bank deposit. That’s because FMPs offer a tax advantage and the prospect of a better yield. Says Madineni: “For investors, the best option, in these uncertain times, is the FMP.”Investors get the benefits of indexation for capital gains for FMPs that are over one year.
Karan Chamindas, Assistant Vice President, PINC Wealth Management, points out that FMPs with a threeyear maturity, offered by ICICI Prudential FMP Series 45, have been offering high indicative yields of 11 per cent. “This is a great option for bank depositors. The post-tax return works out to 10 per cent, which is very good. Investors must park at least 20 per cent of their debt portfolio in FMPs,” says Chamindas.Normally FMPs are open for only four to five days, so you may want to keep an eye out for their indicative yields, which may change.
The liquid brigade
Liquid funds are another option you could consider, particularly if you want to park money for a few days only. These buy paper that mature in a few days and, hence, are able to provide quick access to your cash. Check the quality of paper that a fund will invest in. “Go for funds with a lower maturity date and a high quality paper,” says Chimandas. Consider the tax status as well. Liquid funds pay a higher dividend distribution tax of 28.5 per cent, while Liquid Plus funds, which invest in debt paper with longer maturity of, say, around one week to 1 month, pay a lower dividend distribution tax of 12.25 plus surcharge. Hence, the latter is more tax-friendly.
Floater funds are also an option, if you think the interest rates are likely to rise. These funds will go up if interest rates rise. Invest in funds that are benchmarked to the MIBOR (Mumbai Interbank Bid Offer Rate). Says Nigam: “Efficient floater funds are those that have a daily put option and are linked to the Mibor with an additional 20-30 basis points spread.”