The corporate fixed deposit option

TIME TO GO TRADITIONAL?

After reaping rich dividends from debt funds for nearly four years in a row, it may be time for investors to turn to traditional investment avenues.

Debt funds, which climbed their way up on the back of continuous fall in interest rates, are now set to travel south. In recent months net asset values (NAVs) of debt funds have been volatile - to say the least.

Since the beginning of this week, most of them slipped into negative territory as the hike in cash reserve ratio (CRR) led to mayhem in bond markets. So where do you put your money if you need regular returns? The answer is corporate fixed deposits (FDs).

Today, short-term debt funds or cash funds give a return of around 4 per cent. Bank deposits usually assure returns ranging from 4 to 6 per cent based on the tenure. Corporate fixed deposits promise a return of 6-8 per cent, significantly better than bank deposits and debt funds.

Where fixed deposits pale compared with debt funds is liquidity. Unlike open-end debt funds which offer instant liquidity, fixed deposits are locked in for a stipulated time-period and there could be stiff penalties for premature withdrawals.

However, fixed deposits are available for one-, two-, three- and five-year tenures which makes them better than small savings bonds. Again, income from fixed deposits is taxed at the personal income tax rate. Income upto Rs 12,000 is eligible for exemption under Section 80L.

Obviously, corporate fixed deposits are riskier than bank deposits, so one can always find good companies where risk of default is low. Some trustworthy companies which are accepting deposits currently include HDFC, BPCL, Mahindra & Mahindra, Sundaram Finance, Cholamandalam Finance and Bajaj Finance.

Distributors say the FD market is seeing a revival. However, investors are not yet flocking to FDs the way they did some years ago.

Explains J Rajagopalan, managing director, Bluechip Corporate Investment Centre, "Investor confidence in FDs is shaken because many of them lost their shirt by parking funds in dubious companies trying to chase higher returns."

The biggest risk is that if the promoter turns out to be a cheat and decides not to pay, it is difficult to get your money back. Defaults by manufacturing companies are referred to Company Law Board and those of finance companies to the Reserve Bank, but litigations go on for many years and investors are often left in the lurch.

"Unless the promoters genuinely intend to pay back, there is no way investors can get their money back if a company defaults," says Rajagopalan. For instance, investors in investment company CRB are yet to get their money back after several years of litigation.

So, how does one find safe havens in the world of FDs?

The best way is to go by credit ratings. But there is a catch here. While it is mandatory for all finance companies to get themselves rated, manufacturing companies need not do so. In case rating is not available, investors must follow some simple rules.

Rule No 1 is to completely avoid unknown names. Rajagopalan warns that many unknown names are hitting the market, looking at the soaring retail interest in deposits.

Obviously, they try to allure investors by offering higher returns. Investors must ask why a company is paying higher interest and whether it is capable of managing such high-cost debt. Avoid issuances that offer returns which are way out of the prevailing rates. That's the Rule No 2.

The safety way, however, is to stick to companies that are rated and in fact offer highest levels of safety (AAA).

Besides, investors need to understand the terms and conditions governing the FDs carefully - whether premature withdrawal is allowed or not, if there is any minimum stipulated period and what the penalties for premature withdrawals are.