The Awakening Of The Debt Investor
Fixed-income investors have to now actively scout for the best options as yields are set to change frequently
Putting your fixed-income money to work better means you would now have to check fixed-income rate movements. You will also have to keep an active eye out for fixed-income opportunities as these windows of new offerings or purchases from the secondary market are going to disappear fast. You may also have to embrace volatility if you are looking at debt funds, as they are quoted at market prices.
For some time now, small-savings schemes offered a higher rate, providing the predictability in earnings that fixed-income investors needed. But now, not only have rates been reduced but rate changes in these schemes are going to be made often. These schemes are henceforth benchmarked to market rates, and the re-set will take place every quarter.
But the days of actively managing your fixed-income portfolio has already started. Says Shankar Raman, chief investment officer, Centrum Securities: “It should not upset financial plans, but individuals will now evaluate more options in an objective manner. Earlier people would blindly put it in small savings products. Now, there will be a situation where investors will look for better returns and invest in other products too.”
If you look at the cuts, it looks like a 130-basis-point cut on the post-office term-deposit rate. In effect, the income in the hands of investors has drastically shrunk by more than 15 per cent. Consider this, a simple back-of-the-envelope calculation shows that on a Rs 10 lakh post-office term deposit, an investor used to get Rs 84,000 as interest income. Now, with the new proposals, the interest income shrivelsto Rs 71,000, i.e., Rs 13,000 lower.
For now, the cuts across schemes vary; so would the reduction in incomes. For instance, the new rate on the five-year National Savings Certificate (NSC) stands at 8.1 per cent, against 8.5 per cent, while the popular girl-child scheme, Sukanya Samriddhi Account, will fetch 8.6 per cent, against 9.2 per cent previously. The popular Public Provident Fund (PPF) will yield 8.1 per cent against 8.7 per cent.
All these rates will begin to kick in from 1 April, 2016, but many investors are already anxious about the altered situation and worried about what their next move should be. Fixed-income investors are largely accustomed to steadier and stable income and, by and large, avoid the fluctuations in earnings that come with investing in other asset classes such as equities.
Investors know what they are getting pre-tax and, therefore, can make comfortable assessments of their income and their expenditures in advance. Mostly, fixed-income instruments are used as an important savings arsenal in the retired man’s investing kitty, and most are unhappy about the move.
Experts point out that while people would initially be upset about the fact that interest rates have come down, and the returns in their hands are lower, when viewed in the context of inflation, the yields to investors are still quite high. Says Raman: “You want to earn a return above inflation when you invest in a safe fixed-income instrument. If inflation is going to be around 5-6 per cent, then investors will be more willing to accept returns of 7-8 per cent. People will realign themselves and that realignment will happen over a period of time.”
Real interest rates are critical. When inflation is lower than interest income, there is positive real interest income in the hands of investors. When the real interest rates are negative for long periods of time, investors usually flock to other inflation-beating assets such as real estate and stocks. But, as inflation has been benign for some time now, fixed income investors are still going to be firmly on course to stay ahead of inflation.
A positive real rate of interest is still a good thing. Experts reckon that inflation is likely to stay lower for the foreseeable future and, hence, a lower interest rate now would be the norm. Three years ago, when inflation was higher at around 8-10 per cent, fixed income didn’t really prove attractive, after adjusting for inflation. But now it does. Says Vishal Dhawan, founder and chief financial planner, Plan Ahead Wealth Advisors: “We are still better off with low rates of interest than what we were three years ago. It hasn’t taken away from investing in fixed income as an asset class, because we are still getting a higher return.”
Although the income levels from fixed income will be starkly lower in the coming years, experts advise that investors should not change their financial plans, or embrace anything riskier in their financial investing strategy, but rather just tweak their portfolios somewhat to incorporate some newer investing options.
Looking at product returns are one of the two ways in which investors can compensate for the lower yields. Ramping up investments in fixed income is a better fix, experts point out. For example, if you get an income of say Rs 85,000 per annum, you can increase your deposit by a further 20 per cent or so to around Rs 2 lakh to get roughly the same pre-tax income per annum. However, not everyone will be able to amp up their investments because that would involve raising more resources.
Hence, the better and longer-term fix is to actively seek investments that would increase your returns without adding more risk to your portfolio. There are fixed-income options available where investors can still make decent returns, but investors may have to tweak their investing horizon and also actively scout out the market place for investment options.
If you have been a do-it-yourself investor all these years and have been looking at the vanilla investment options such as bank and corporate fixed deposits, maybe it’s time to take the assistance of financial advisors. There are a lot of options out there in the fixed-income world and picking and choosing between the myriad investing options does not come easy.
But for the self-initiated, here are a few options to consider. First, if you are in the lower-income bracket, the humble fixed deposit of postal deposits and corporates could still continue in your fixed-income kitty. You would get a lower return, but your investment is safer with these schemes. You should also look at the credit quality of investments and go only with the highly rated instruments. Says Raman:“One has to be very careful about credit quality. You have seen mishaps in the last few months and one has to go through this category via mutual funds only.”
If you are in the higher-tax bracket, you could look at investments in tax-free bonds and debt mutual funds. Says Raman; “I would think the opportunities are there in the tax-free bonds, and in a few debt mutual funds. If, indeed, interest rates are going to come down, then this is a good opportunity for fixed-income investors.”
Investors can also look for tax-free bonds in the market, although sometimes these products have low liquidity and one may not be able to easily get their hands on them. But investors who do manage to snag a few can not only get a coupon rate here, but also benefit from falling yields as bond prices rise, offering capital gains to investors.
Says Dhawan: “For investors who have not bought a lot of the tax-free bonds, they should be looking at the secondary market to add some. Tax-free bonds and dynamic bond funds benefit from falling interest rates.”
Medium- to long-term debt funds offer some of the most attractive options for now especially as interest rates are headed lower. When interest rates fall, the prices of bonds rise. Experts reckon that the inflation trajectory is looking weaker, which means that interest rates could further head south. Says Raman: “There will be more room for the RBI to act to bring down interest rates. And, hence, with tax-free bonds and some debt funds, investors will not only make some coupon, but also see some capital appreciation.”
Over the coming years, more options for investors will open up as the bond market is set to expand with more mid-cap companies tapping the markets. High net-worth individuals have additional options in derivative products and exotic and structured products; but these can be expensive. One option, if one does not require the liquidity, is to look for fixed maturity plans and hold them for a period of three years; these accrual products are attractive due to the lower tax.
All in all, the fixed-income market is only set to expand with more options for investors. With a little home-work and some scouting, investors can still make the most of fixed-income investing in the next few years. If all goes well and rates come down, for investors in the longer-term variety of debt mutual funds the additional capital gains would be an added bonus. If not, investors will have to just go by the lower returns.
ON THE INTEREST TRAIL
Things investors should know if they have their monies invested in fixed-income instruments
1 Small-savings schemes still offer good enough returns, since the real rate of return is still positive as inflation has fallen
2 Linking small-savings schemes to market rates would mean investors have to actively manage their debt investments
3 Either investors have to increase their investment corpus to obtain a similar income or embrace riskier investments
4 Market-based products are volatile and yield spikes will impact prices of traded fixed-income securities
5 As interest rates are heading lower, investments in market-based options such as debt funds could prove rewarding
6 Watch the post-tax returns as taxes could eat away a significant portion of your fixed-income earnings
7 Investors should have a basket of fixed-income products and should optimally balance between risk and return
8 Always take a look at the credit quality and go for the higher-rated products before investing in fixed income schemes