 "Fixed deposits, NCDs score for one-year horizon")
For investments in the one to three-year horizon, investors are increasingly choosing fixed income instruments such as fixed deposits, non-convertible debentures (NCDs) and tax-free bonds over fixed maturity plans (FMPs).
In July, Shriram Transport Finance had raised about Rs 3,000 crore through a primary issue of NCDs. The interest coupon offered to individual investors was 10.7-11.5 per cent, depending on the payout option and tenure of the bond. Within days, the issue was fully subscribed, in all categories.
Earlier, ECL Finance had raised about Rs 400 crore through a similar NCD issuance.
Let us consider how these instruments fare in terms of returns, liquidity, risk and taxation:
For a one-year investment horizon, fixed income instruments such as corporate fixed deposits and NCDs have become popular. However, short-term debt and liquid funds continue to attract investments, due to their competitive yields and the ability to offset short-term losses the investors might record for tax planning with short-term gains from such funds, says Sriram Iyer, chief business officer, Religare Private Wealth Management. "Investors should diversify their debt portfolio across various debt instruments to enhance risk-adjusted returns. While taxation is an important consideration, it should not be the only factor to consider allocations in fixed income," he says.
Anshu Kapoor, head (private wealth management), Edelweiss Financial Services, says for an investment horizon of at least a year, the most popular investment option is tax-free bonds. "Interest received from tax-free bonds is exempt from tax, but capital gains continue to be subject to tax at 10 per cent, if held for more than a year. Like other listed bonds, corporate NCDs also enjoy long-term capitals gains for more than a year. This is an attractive option for an investment of one to three years," he says.
While company FDs have typically been popular with small investors due to the regular interest income, recently, even high net worth investors have started investing in these, says the head of a private wealth management company. "For some recent company FDs, we saw the average investment was about Rs 75,000. This means high net worth individuals, too, are investing in these. Company FDs offer higher returns than bank FDs, and it is fixed over the entire tenure. That is an advantage for investors," he says.
Avoid FMPs of less than three years
While fresh inflows into FMPs have been lower, most asset management companies are providing investors the option to roll over existing FMP investments (a one-year FMP will offer a two-year extension) to avoid higher taxation. According to estimates, about half the FMP schemes due for maturity in July have been rolled over to a three-year period.
Experts say FMPs are recommended for investors averse to volatility in returns, provided they are comfortable locking in funds for at least three years. "Given the longer lock-in tenure, most investors prefer arbitrage and short-term funds, which offer similar returns, but provide liquidity. FMPs with tenures less than three years are inferior to FDs and corporate bonds and, therefore, are avoidable," says Kapoor of Edelweiss.
FMPs invest in debt instruments of the same maturity, or residual maturity of the same tenure. In the case of one-year FMPs, the scope for volatility in interest rates is less because the fund house will invest in one-year commercial papers or certificates of deposit. But in case of FMPs of longer tenures, the fund house will invest in debentures and other debt instruments. So, there might be some volatility in interest rates. "Investors could look at rating the papers. If you don't want any volatility, you could invest in an FMP that invests only in highly-rated papers. But the returns could be lower," says Hemant Rustagi, chief executive, Wise Invest Advisors.
How safe are these instruments?
Corporate FDs and NCDs are subject to credit risks of the issuer. As such investments are unsecured, the investor faces the risk of default on interest or principal at the time of maturity. So, always check the rating of the issuer company in case of corporate FDs and NCDs.
Corporate FDs have stringent early-penalty provisions that have to be considered before investing. Liquidity of corporate NCDs in the secondary market is also a concern.
"Given that the tax arbitrage between bank FDs and MFs doesn't exist any more, on a comparative basis, bank FDs are safer and more liquid, despite the premature withdrawal penalty the investor will be subjected to," says Iyer.
While FDs and FMPs are on a par in terms of post-tax returns, NCDs offer higher returns. But remember, NCDs also have default and mark-to-market risks---their prices move with interest rate movements. This creates uncertainty in returns in case you want to exit before the maturity of the bond, says Kapoor.
Recent NCDs issued by non-banking financial companies such as Muthoot Finance, Mannapuram Finance, Sriram Transport Finance and SREI Infrastructure Finance have all been fully subscribed.
Tax-free bonds
Currently, tax-free bonds are trading at yields of just 7.25-7.3 per cent, making these attractive compared to other investment options. But since the 2014-15 Budget didn't provide for additional limits to public sector undertakings, in terms of issuance of tax-free bonds, the only option for investors is to buy these through the secondary market.
"The higher demand for tax-free bonds compared to the supply has led to lower volumes for these bonds. The liquidity for these bonds is likely to improve once fresh primary market limits are issued," says Kapoor.
"Tax-free bonds offer investors capital appreciation through the medium term, as and when interest rates soften. One can also buy these in the over-the-counter market, through fixed-income arrangers," says Iyer.
Structured products
These are only for high net worth investors, as the least ticket size of investments is Rs 25 lakh. Structured products have been popular among high net worth investors because of their ability to be tailored to capture any specific market view. However, given the size of investment is at least Rs 25 lakh, these have remained an investment option only for investors who can take informed decisions on the credit quality of the issuer, the liquidity and the market risk involved in these investments. As these are akin to debentures, capital gains from these instruments continue to enjoy long-term treatment (beyond 12 months), making the more tax-efficient compared to debt funds.
In July, Shriram Transport Finance had raised about Rs 3,000 crore through a primary issue of NCDs. The interest coupon offered to individual investors was 10.7-11.5 per cent, depending on the payout option and tenure of the bond. Within days, the issue was fully subscribed, in all categories.
Earlier, ECL Finance had raised about Rs 400 crore through a similar NCD issuance.
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So far, FMPs issued by mutual fund houses scored over other short-term debt instruments due to the tax treatment. But Budget 2014-15 did away with the tax arbitrage, saying only FMPs of at least three years were eligible for long-term capital gains exemption. Therefore, investors are now looking at a mix of other instruments, too, in their debt portfolios.
Let us consider how these instruments fare in terms of returns, liquidity, risk and taxation:
For a one-year investment horizon, fixed income instruments such as corporate fixed deposits and NCDs have become popular. However, short-term debt and liquid funds continue to attract investments, due to their competitive yields and the ability to offset short-term losses the investors might record for tax planning with short-term gains from such funds, says Sriram Iyer, chief business officer, Religare Private Wealth Management. "Investors should diversify their debt portfolio across various debt instruments to enhance risk-adjusted returns. While taxation is an important consideration, it should not be the only factor to consider allocations in fixed income," he says.
Anshu Kapoor, head (private wealth management), Edelweiss Financial Services, says for an investment horizon of at least a year, the most popular investment option is tax-free bonds. "Interest received from tax-free bonds is exempt from tax, but capital gains continue to be subject to tax at 10 per cent, if held for more than a year. Like other listed bonds, corporate NCDs also enjoy long-term capitals gains for more than a year. This is an attractive option for an investment of one to three years," he says.
While company FDs have typically been popular with small investors due to the regular interest income, recently, even high net worth investors have started investing in these, says the head of a private wealth management company. "For some recent company FDs, we saw the average investment was about Rs 75,000. This means high net worth individuals, too, are investing in these. Company FDs offer higher returns than bank FDs, and it is fixed over the entire tenure. That is an advantage for investors," he says.
Avoid FMPs of less than three years
While fresh inflows into FMPs have been lower, most asset management companies are providing investors the option to roll over existing FMP investments (a one-year FMP will offer a two-year extension) to avoid higher taxation. According to estimates, about half the FMP schemes due for maturity in July have been rolled over to a three-year period.
Experts say FMPs are recommended for investors averse to volatility in returns, provided they are comfortable locking in funds for at least three years. "Given the longer lock-in tenure, most investors prefer arbitrage and short-term funds, which offer similar returns, but provide liquidity. FMPs with tenures less than three years are inferior to FDs and corporate bonds and, therefore, are avoidable," says Kapoor of Edelweiss.
FMPs invest in debt instruments of the same maturity, or residual maturity of the same tenure. In the case of one-year FMPs, the scope for volatility in interest rates is less because the fund house will invest in one-year commercial papers or certificates of deposit. But in case of FMPs of longer tenures, the fund house will invest in debentures and other debt instruments. So, there might be some volatility in interest rates. "Investors could look at rating the papers. If you don't want any volatility, you could invest in an FMP that invests only in highly-rated papers. But the returns could be lower," says Hemant Rustagi, chief executive, Wise Invest Advisors.
How safe are these instruments?
Corporate FDs and NCDs are subject to credit risks of the issuer. As such investments are unsecured, the investor faces the risk of default on interest or principal at the time of maturity. So, always check the rating of the issuer company in case of corporate FDs and NCDs.
Corporate FDs have stringent early-penalty provisions that have to be considered before investing. Liquidity of corporate NCDs in the secondary market is also a concern.
"Given that the tax arbitrage between bank FDs and MFs doesn't exist any more, on a comparative basis, bank FDs are safer and more liquid, despite the premature withdrawal penalty the investor will be subjected to," says Iyer.
While FDs and FMPs are on a par in terms of post-tax returns, NCDs offer higher returns. But remember, NCDs also have default and mark-to-market risks---their prices move with interest rate movements. This creates uncertainty in returns in case you want to exit before the maturity of the bond, says Kapoor.
Recent NCDs issued by non-banking financial companies such as Muthoot Finance, Mannapuram Finance, Sriram Transport Finance and SREI Infrastructure Finance have all been fully subscribed.
Tax-free bonds
Currently, tax-free bonds are trading at yields of just 7.25-7.3 per cent, making these attractive compared to other investment options. But since the 2014-15 Budget didn't provide for additional limits to public sector undertakings, in terms of issuance of tax-free bonds, the only option for investors is to buy these through the secondary market.
"The higher demand for tax-free bonds compared to the supply has led to lower volumes for these bonds. The liquidity for these bonds is likely to improve once fresh primary market limits are issued," says Kapoor.
"Tax-free bonds offer investors capital appreciation through the medium term, as and when interest rates soften. One can also buy these in the over-the-counter market, through fixed-income arrangers," says Iyer.
Structured products
These are only for high net worth investors, as the least ticket size of investments is Rs 25 lakh. Structured products have been popular among high net worth investors because of their ability to be tailored to capture any specific market view. However, given the size of investment is at least Rs 25 lakh, these have remained an investment option only for investors who can take informed decisions on the credit quality of the issuer, the liquidity and the market risk involved in these investments. As these are akin to debentures, capital gains from these instruments continue to enjoy long-term treatment (beyond 12 months), making the more tax-efficient compared to debt funds.