Prime Minister Narendra Modi launched the Reserve Bank of India’s (RBI) Retail Direct Scheme (RDS) last week. This scheme was first announced in February this year and offers a direct channel for investment in government securities (G-Secs), including central government securities, treasury bills, state development loans (SDLs) and sovereign gold bonds (SGBs).
Choose a maturity of your liking
RDS will mean better liquidity for investors. “It will become easier for retail investors to sell the G-Secs they have purchased using this facility. Secondary market liquidity was low in the broker-exchange system, the alternative route through which investors could also buy and sell G-Secs,” says Udbhav Rajeshbhai Shah, investment advisor, iFast Global Markets.
Primary issuances in G-Secs are for 10, 15, 30 or 40-year tenures normally. “A person may want to invest in G-Secs with residual maturity of, say, 11, 16, or some such years that matches her investment horizon. She will be able to purchase them from the secondary market,” adds Shah.
Investing in G-Secs via this route involves no cost. “When you buy a bond through the exchange-broker route, you pay a brokerage. Gilt mutual funds also have a recurring annual cost—the expense ratio. This scheme has no transaction cost,” says Joydeep Sen, corporate trainer and author.
Lock-in rates for long term
Very few fixed-income instruments have a tenure of more than 10 years. Fewer still allow you to lock in rates for such a long period. Conservative investors, who wish to avoid equity-market volatility, can use G-Secs to lock in rates for the long term. Interest rates could decline over the long term. “You can use this product to lock in interest rates for up to 40 years,” says Shah.
People planning for retirement, or those who have retired, can use them. G-Secs offer half-yearly pay-outs and can fulfil the needs of investors who need regular cash flows.
One government-backed instrument that investors use to lock in rates is the RBI Savings Bond (7.15 per cent interest, taxable). "These bonds come with complete lock-in though you can get a loan against them. But you can sell G-Secs in the secondary market and can also pledge them,” says Anand Nevatia, fund manager, Trust Asset Management Company. You can also invest in them online.
Since G-Secs of different maturities will be available, investors will be able to ladder their investments. “You can invest in G-Secs of different maturities based on your cash flow requirements,” says Sen.
Sometimes, in a rising rate environment, the returns from G-Secs can be better than those offered by bank fixed deposits (FDs) or even Post Office schemes. This happens because rate transmission occurs faster in the markets, while banks and the Post Office take more time to pass on the benefit of higher rates to customers. Vigilant investors can benefit from such situations.
SDLs offer better returns (50-100 basis points) than G-Secs. Investors can benefit from this. However, data on the availability of old issuances of SDLs—how many are outstanding, their maturity dates, etc—is not easily available, say experts.
You can also gift G-Secs. If interest rates go down, then a couple of decades later your children will be grateful for the gift of these higher-yield bonds.
Beware of interest-rate risk
There is a perception that G-secs carry no risk. This is misleading. “While G-Secs carry no credit risk, they do carry mark-to-market risk,” says Pankaj Pathak, fund manager-fixed income, Quantum Mutual Fund. If you buy a 10-year bond and decide to exit it after two years at a time when interest rates are on the upswing, the price you get for the bond could wipe out the interest income you have earned from it over two years.
Trying to take duration call using G-Secs can prove risky. If you have an investment horizon of five years, avoid investing in a bond with a six-year residual maturity, even if it pays 10-20 basis points more.
Since RDS is new, liquidity could be an issue in the initial years. “This is a new platform. It will take some time for it to become popular among retail investors. Liquidity will improve as that happens,” says Nevatia.
Finally, avoid taking interest-rate risk in them. “Match the maturity of the G-Sec you choose with your investment horizon to avoid intermittent mark-to-market (MTM) shocks," says Nevatia. Pathak too says G-Secs can be a good investment option for investors who follow a buy-and-hold approach.
G-Secs
· The threshold holding period for categorisation into short- or long-term capital gains (STCG or LTCG) is one year for zero coupon bonds and three years for other bonds
· The tax rate is 10 per cent on LTCG for listed G-Secs with no indexation benefit taken
· It is 20 per cent for listed G-Secs when indexation benefit is taken
· It is also 20 per cent for unlisted G-Secs where no indexation benefit is allowed
· Short-term capital gains are taxed at marginal slab rate
Gilt mutual funds
· Gains are categorised as short-term for holding period up to three years, and long-term otherwise
· LTCG is taxed at 20 per cent under Section 112 after availing indexation benefit
· Short term capital gains are taxed at investor’s marginal slab rates
Source: RSM India