Article | Sip - Feb 15, 2017 | 12:59 PM
November 8, 2016, was a landmark event for India’s economy perhaps comparable only by the 90’s liberalization move. Prime Minister Narendra Modi virtually stunned the entire population in one swift move turning almost 86% of the currency into ‘worthless paper’. The announcement made in the evening had everyone collectively dropping jaws and making a beeline to the nearest ATM.
Even couple of months after the historic move, demonetization continues to dominate the news. With the entire country debating the long-term effects of demonetisation, one visible impact is that deposits have got a shot in the arm. According to the data available with the Reserve Bank of India (RBI), as of 30th December 2016 Rs 14.97 trillion have been deposited in banks. At the same time, the cash crunch has forced a weekly withdrawal limit of Rs 24,000. Considering the withdrawal restrictions, it can be safe to assume that a large chunk will continue to sit idle in accounts. The central government has launched a special App, namely BHIM to promote e-transactions. In just a few days, it has become the number 1 downloaded App in India.
Banks, now flush with funds have begun to cut deposit rates. Major commercial have already slashed rates. Since the demonetization move, bond yields have fallen as well. Because bond yield is inversely proportional to bond prices any drop in yield will lead to an appreciation of bond prices. Both in tandem will incentivise to the RBI to cut rates. And with falling food prices and disinflation, everyone seems to be expecting further rate cuts from the RBI. Investors planning to open fixed deposits are being advised to open accounts quickly to lock in at the current rates, as there is anticipation that the rates will fall further.
Demonetisation has definitely left investors dazed and a bit confused. However, people with money in traditional instruments have several attractive options to deploy this cash ranging from mutual funds to bonds. The main parameters considered are liquidity, low risk, potential high returns and the ever relevant tax rates. Among the many options, investing in debt mutual funds seems to be quite a favourable option.
The Indian mutual fund industry has done remarkably well over the past few years. According to AMFI figures as of 30th November, 2016, the total assets under management (AUM) is pegged at Rs 16.94 trillion, debt oriented schemes are on the rise and comprise 45.4% of the industry assets and at 64%, institutional investors and banks continue to dominate debt oriented schemes while individual investors comprise of just 36%.
Falling interest rates have resulted in an increase in bond prices which has had a positive impact on debt funds. While the main complaint of many investors is volatility especially when they invest in equities; debt funds can allay these fears, as they invest in government bonds, corporate bonds, non-convertible debentures (NCDs) and bank certificates. Each type of bond has a credit risk rating. Government bonds have a sovereign rating which is the highest and virtually means zero risk. Similarly, corporate bonds are rated by credit agencies from AAA (highest) to D (default). Different credit agencies have different annotations, so be sure to check the grading system. Hence with the information easily available, the investor can make a smart choice and choose wisely.
Short-term debt funds usually post reasonable one year returns and like traditional investment options, short-term capital gains are taxed according to the investor’s tax brackets. So the main concern would be post-tax returns and tax alpha. Tax alpha in simple terms is the performance of a fund compared to another market index or benchmark index. The difference between the two or excess returns often shown as a percentage is known as the tax alpha.
Even with tax considerations, any debt term investments above three years (long term) can get the benefit of indexation which is adjusting the price for inflation. This could bring down the effective tax down from 20% for the investor.
Finally, returns should not be the only parameter for investing. The investment has to align with the investor’s objective and risk taking capacity. Instead of hasty investments, follow legendary investor Warren Buffet’s advice, “Never invest in a business you can’t understand”. Demonetisation or not, cash lying is not ideal for any investor or for people aiming to create wealth.
Disclaimer: Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
Has demonetisation nudged you towards Mutual funds?