Inflation is killing as it has been at high levels for over
three years now. Stocks markets have gone nowhere in this period, with the
possibility of a slide down the slope, due to worsening fundamentals in the
Indian economy and the adverse effects
of the debt overhang in Europe and the not-too-good position in the US.
Investors have got tired of waiting for returns in equities.
Some have commented to me that they would have been better off investing in
fixed deposits itself, rather than equities.
While that looks fine on the
surface, equities tend to perform over the long-term. Now, there is debate on
what constitutes long-term. The normal
definition of 3-5 years is being questioned, as in the past 5 years too,
equities are showing negative returns. We are in uncertain times now. For those who want to play safe, this is
indeed a good time – for the interest available for fixed income instruments
have peaked and there are quite a few viable options for constructing a fixed
income portfolio.
1.
Fixed Maturity Plans ( FMPs )- FMPs with one to three year durations are
available from Mutual Fund companies which offer between 9-9.5% returns. That
may not look like much. But the tax treatment for FMPs are benign. For a
period beyond one year, capital gains
need to be calculated and taxes applied. Capital gains taxes beyond one year is
10% without indexation and 20% with indexation. Due to this, the net returns
are estimated to be between 8.8% - 9.2%. Now that is not bad, is it? Also, the instruments into which FMPs invest
have maturities that more or less coincide with the tenure of the FMP. This would ensure that there is no scope for
variability in the returns and would get the coupon rates of the underlying
instruments, irrespective of any changes in the interest rate cycle in the
interim.
2.
Debt Funds – Debt funds are probably very good
instruments in the fixed income space as they offer coupon rates of the
underlying instruments as well as the potential for capital appreciation. When
interest rates start moving down in the system, the underlying instruments
which would have coupons higher than the prevailing rate, would rise in value. This
would mean an increase in the NAV of debt funds, which hold such instruments.
Hence these debt funds have the potential to offer double digit post-tax
returns, in a falling interest rate scenario. The funds which hold comparatively
longer tenures could offer higher capital appreciation, in a falling interest
rate scenario.
But then, there are different kinds of debt
funds. Some of them are dynamically managed funds, where the duration and the
instruments are decided by the fund manager. In such funds, the fund manager
keeps moving in and out of various instruments and manages the fund based on
the unfolding situation. Some of the funds follow a clear buy and hold strategy
as well. Funds which hold gilts could be volatile, but also have maximum
potential to offer returns in a falling interest rate scenario.
3.
Short tenure Debt Funds - Those looking at about
one year could look at funds that invest in Ultra short term funds & short
term funds. The nomenclature is a bit fuzzy here. Depending on the tenure these
may invest in corporate bonds, Certificate of deposits ( CDs) of upto one year
tenure ( CDs of one year tenure are
today yielding about 10% now ) & Commercial Paper of short tenures. These funds can yield attractive returns,
even over short periods of less than one year.
Shorter tenure funds, with tenures
of less than one year are designated ultra short-term funds. Such funds
typically invest in instruments of very short tenures only. Since 3-month CD is offering 9.85% and 3 month Commercial Paper is
offering 10.15%, ultra short-term funds would be able to offer attractive
returns today. The best option to choose
would be dividend, as the dividend distribution tax here is 13.5%, whereas the
tax would be as per the tax-slab if Growth option is opted for. Hence, Ultra
short-term fund would be an excellent place to park short-term money, given that
short-term bank FDs would offer 5-6% pretax return and SB account would offer
4-6% pretax return.
4.
Fixed deposits – This is a favorite among people
who want to play safe with their money. Bank fixed deposits is a vehicle of
choice among the public, primarily due to the low risk associated with it. A one to three year deposit today is offering
9-10% returns today pretax. There are also company fixed deposits which could
offer upto 1-2% more. But they are somewhat higher on the risk measure and the
investor is advised to look at the rating assigned to the offering before
investing. Triple A indicates highest level of safety and AA+ indicates a very
good level of safety for return of principal and for receiving interest.
5.
PPF – PPF has traditionally been an attractive
vehicle for investment, as it offers tax-free returns, which currently stands
at a whopping 8.8%! Though PPF is a long-term instrument and liquidity is
constrained, it has it’s set of followers and with good reason. One can invest
upto Rs.1 Lakh in an account per year, which offers good savings potential for
the family.
6.
Bonds – Tax free bonds which came up last year,
was a hit with the public. They were again long-tenure instruments of 10-15
years, which had yields of 8.2-8.3%.
These are attractive yields over the long-term. In a sense, it is even better
than PPF, as these returns are assured over 10-15 years. PPF returns can change
year-on-year and can go much lower than 8.8%, at present. Even those who have missed the bus then can
buy from the bourses, at an yield of about 8% now. That still presents an
attractive opportunity.
In sum, there are many attractive fixed income instruments
available at this time. The portfolio can be constructed using these
instruments according to the specific requirements of the investor. There is also the comfort that this is going
to yield a decent positive return, irrespective of what happens to our stock
markets, our economy and the global economy.
Published in Business Standard on 27/5/2012; Author : Suresh Sadagopan, www.ladder7.co.in
