Not happy with FDs? This could be a way out

Banks are continuing to slash fixed deposit (FD) rates, putting pressure on those who survive on interest income. For instance, SBI has cut FD rates to 6.6% for senior citizens and 6.1% for others as of 10 January. Big private banks are also not offering much more. The highest interest rate offered by HDFC Bank is only 6.9% for senior citizens and 6.4% for others.Though fixed deposit rates are low, yields on listed bonds from quality companies are at higher levels, providing an opportunity for savvy investors. Unlike FDs, buying bonds from the market can be complicated. Therefore, while getting into the listed bonds space, investors need to make sure they are investing in the right bonds. They can filter their needs based on the following factors.RiskThe first factor to consider is your risk appetite and risk taking ability. This is because several bonds from companies like Dewan Housing Finance, Reliance Home Finance, etc. are now trading at very high yields. Don’t be in a hurry to buy though. “Investors should be careful with papers offering very high yield and understand that high yields are due to the risk associated with it,” says Anil Rego, Founder & CEO, Right Horizons. In other words, these bonds are meant only for highrisk takers. Retail investors, especially those who want to shift from bank FDs, should steer clear of low-quality papers. “Considering the credit situation, it is better retail investors concentrate on highly rated bonds only,” says Amit Kachroo, Managing Partner, Aaneev Wealth.The bonds from several high quality companies are now trading at a yield of 8.5% or above. “Retail investors should consider investing in taxable listed bonds with AAA rating now because the return gap between safe bank FDs and AAA rated bonds is almost 2%,” says Deepak Jasani, Head of Retail Research, HDFC Securities. The yields on bonds from SBI are placed around 8.8% now (see table). Please note we have only included high quality bonds in the table. Taxable bonds work for those in lower brackets 73608846 TaxTaxation and tax slabs should be considered next. Listed tax-free bonds are good options for people in the high tax brackets. The yields on tax-free bonds are now in the range of 5.6-5.9% (see table). “Since the pre-tax yields on tax-free bonds are now at around 8.5% for people in the 30% tax slab, it is the best option for HNIs,” says Rego. Since these bond issuers are highly rated public sector undertakings, the risk involved here is also very low.Pre-tax yield is high for tax-free bonds 73608858 Note: Only bonds with Rs 1 lakh turnover included. Data as on 22 Jan. Source: NSE websiteLiquidityMost banks allow immediate withdrawal from FDs, but you can’t do the same with listed bonds. For liquidating your investments, you need to sell these in the market and money is credited to your account only after a few days (payout day). Another issue is all these listed bonds are not traded frequently. “While investing in listed bonds, investors should be careful with liquidity. You may get into trouble if you buy bonds with low liquidity and want to sell them before maturity,” says Rego. Spreading purchases and sales is another option. “Since the liquidity in many papers is not that great, large investors have to spread their purchases/sales over a few days,” says Jasani. As illustration, we have only included bonds with at least Rs 1 lakh traded value. Consider bond ETFs tooBuying into listed fixed duration bond funds is another option investors can consider now, because mutual funds are treated differently. Since the 20% long term capital gain tax here is levied after indexation, the tax liability will be low. For instance, let us assume that one of these ETFs generates a return of 7% for a 3-year holding period and the inflation during the time is 4%. Since the 20% tax is applicable only to the inflation adjusted returns—3% in this case, the post-tax yield will be 6.4%.Bond ETFs offer indexation benefits, and are suitable for HNIs 73608862 As visible from the bond ETF table, low liquidity is an issue in this segment too. Though there is enough liquidity in the recently introduced Edelweiss Bharat Bond ETF counter, experts are concerned that the scheme is not yet fully invested. However, the fund house says this issue has been resolved. “Portfolios are fully invested in both 3 and 10 year ETFs,” says Radhika Gupta, CEO, Edelweiss AMC.The main advantage with these listed ETFs is that you can time the market based on its running yields. “For new investors, the portfolio yield of the 3-year ETF is between 6.7% and 6.8% and posttax yield after indexation benefit can be around 6.2%. For the 10-year ETF, the yield is placed between 7.5% and 7.6% and the post-tax yield after indexation can be around 6.9%,” says Gupta. The default risk is not applicable for these ETFs because all these schemes are based either on government securities or with AAA rated PSUs.

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