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Dart At Debt To Dump Risk

BW Online Bureau Nov 08, 2014

<?xml version="1.0" encoding="UTF-8"?><root available-locales="en_US," default-locale="en_US"><static-content language-id="en_US"><![CDATA[(Pic By Bivash Banerjee) Having an anchor in your life is important. And in the financial world, that anchor is investment in debt, which can get you a steady stream of income. You could look at a suite that covers deposits — banks and non-banks; bonds (government and corporate), debt mutual funds, provident funds and postal savings. Of course, where one invests depends on one’s station in life. So, does it make sense now to invest in debt given that the bourses are getting back into life? Let us start with deposits. Bank deposits are the safest by far. Currently, a one-year bank deposit will fetch you 6-7 per cent or thereabouts; down from around 10 per cent a year ago. “Frankly, it (such an investment) is a no-brainer,” says Kartik Jhaveri, director of Transcend Consulting. “The returns depend on the tax bracket you are in. In the highest tax bracket, you will lose a third of the interest income earned in tax. What is the point?” Of course, while there is also a view that interest rates per se may harden in the months ahead if the much-hoped-for (and hyped) economic recovery kicks in, nothing still changes on the taxation aspect on the interest earned. Safety Is A Factor A better bet, Jhaveri says, is to opt for non-bank deposits — of companies or of non-banking finance companies (NBFCs). However, unlike a bank deposit, there is no insurance cover of up to Rs 1 lakh. So the key factor to watch for is safety — credit ratings can give you an indication. While non-bank deposits offer higher returns, the downside is that these companies may hit an air pocket, and their financial ability may be affected. In the mid-to-late 1990s, scores of NBFCs vanished into thin air after duping depositors — the most infamous of them being CRB Capital. In the current economic environment, when the financials of even the most respected companies are stretched a bit, it may not be wise to invest in NBFC deposit schemes. The point to be borne in mind is that the best in any category — banks or non-banks — will offer you the least by way of returns. The higher the risk, the higher the return offered. That is the trade-off. And in tax treatment on the interest earned, there is no difference between bank, corporate and NBFC deposits. If at all you want more in terms of return, do go for non-bank deposits of blue chips. There is another non-bank avenue. And that is debentures issued by companies. In this case, while the returns will not be much higher than non-bank deposits, an advantage is that debentures are secured by the assets of these firms. The flipside is that they are illiquid (even though they are tradable) — there is no secondary market where one can sell it like in the case of equities. You have to go back to the company if you need the money right away. And if there is a lock-in period for such investments, it can prove to be a double whammy. Banks are also reluctant to lend against such investments. “It is better to ask an adviser about the pros and cons of such investments,” says Bekxy Kuriakose, senior fund manager for fixed income at DBS Cholamandalam. “Not all debentures are secured.” Not Too Attractive One safe avenue is government securities. An investor can open an account with a bank and purchase such securities. This can be done at the time of auction of bonds by the Reserve Bank of India (RBI) — there is a component called ‘non-competitive bids’. One can also buy government securities in the secondary market — routed through a bank — or from a primary dealer. Figures in %; *assuming a 30 per cent tax bracket Source: BW research, mutualfundsindia.com, bajajcapital.com These are risk-free, but the returns are not attractive. Then, given that retail investors — other than high networth ones — will go in for small lots, the illiquidity premium will have to be borne by them. “It makes no sense,” says Kuriakose. Investments in bonds — government and corporate — are illiquid, and the debt segment on the bourses (the Bombay Stock Exchange and National Stock Exchange) are institutional in nature. “Investors will also need to know about how the government securities markets work and the movement in interest rates,” she says. And, therefore, such an investment is best avoided. The one debt instrument that has been pampered by the government so far in terms of tax treatment is mutual funds’ debt schemes. While you earn interest in any other debt instrument, in a debt mutual fund you earn a gain from the difference between the lower price at which you bought its units and the higher price at which you redeem them. This gain is taxed at just 10 per cent, making it attractive for investors. What are the prospects of debt funds in the next one year? Debt funds come in many hues and colours — liquid funds, ultra short-term debt funds, short-term income funds and long-term income funds. Some of these are floating rate funds as well, although the proportion of floating rate instruments in these funds is abysmal, ranging between zero and 5 per cent, effectively making them fixed-rate debt funds. And just like in the case of investing in government securities, an understanding of interest rate movements and developments in the macro-economy will take you a long way. Given the downward interest rate movement for some more time, it is advisable to invest in liquid funds and ultra-short term debt funds. “Between now and December, we would recommend liquid funds for the debt investor who understands the significance of marked-to-market nature of debt funds,” says Lakshmi Iyer, vice-president and head of fixed income at Kotak Asset Management. Iyer expects interest rates to harden in the last quarter of the current financial year. And laments the absence of a vibrant debt futures market in India that otherwise would have provided more options to retail investors. Of course, investors also have to remember that mutual funds — debt or equity — can be risky if there is a liquidity crunch. In September-October 2008, mutual funds faced unusual redemption pressure, and RBI had to open special liquidity windows. The bottom line is that while debt instruments may appear safer than equity, like much in life, appearances can be deceptive. Play safe, invest wisely. And pray! raghu(dot)mohan(at)abp(dot)in (Businessworld Issue Dated 21-27 July 2009)