Inflation Indexed Bonds: Points to remember

In an interview to CNBC-TV18, Certified Financial Planner, Gaurav Mashruwala shared views on inflation-indexed bonds and what should a retail investor look for while investing in such products.

Also Read: RBI to kickstart sale of inflation-indexed bonds on June 4 Below is the verbatim transcript of Mashruwala's interview with CNBC-TV18. Q: How retail investors should approach inflation indexed bonds and what are the points that should be kept in mind? A: The Reserve Bank of India (RBI) has made an announcement about inflation-indexed bonds and the finance minister spoke about this. However, it is a bit early to say. I appreciate the product and it is much better compared to a standard bond whereby principal amount remains intact, same throughout the tenure irrespective of inflation and to that extent if one loses to inflation then they are talking about linking it to Wholesale Price Index (WPI). The problem is that wholesale price index is not the inflation that a common man suffers. He suffers much higher inflation but it is still better than not having anything. The principal amount will nominally get adjusted based on the inflation numbers. So, if inflation goes up as it usually does then principal amount will be automatically treated to be a higher amount and on that one would pay the interest rate. Things that a common man should look into while investing into it is (a) what is the initial coupon rate, what is the initial rate of interest because while principal amount nominally will keep going up if the rate of interest is lower compared to what is being offered in other bonds right now then it is not too much of any interest to a person (b) is there liquidity option. There is a good possibility of this happening whereby there will be listing on the stock exchange though we yet to get complete details but after that do small size trade happen. Therefore, what a retail investor should look for is what is the eventual coupon rate that comes up and the liquidity having said that this is a better product compared to a product whereby for a 10-year the principal remains irrespective of rate of inflation. So, better product but wait and watch. _PAGEBREAK_ Caller Q: I am a new investor and would like to know which category of mutual funds would be the safest bet for me?
 
A: Difficult to say safest because risk and return both go hand-in-hand. If your goals are long-term then look at equity as an asset class and as you said you are a new investor then maybe you should start with index fund. If there are near-term goals like to fund your marriage or if there is any kind of education aspiration that you have and you likely to require money in next two-three years then choose debt based mutual funds where principal remains protected but you lose to inflation. So, it depends what you are saving for. Anybody starting new with a near-term goal of two-three years then choose debt based instruments, debt based mutual funds. Long-term, seven to nine years and beyond chose an equity start with an index fund, go to actively managed fund and for interim period make combination also you may like to add gold fund to balance your portfolio. So, based on your goals pick and choose the asset class and the underlying scheme that you want. Q: Gold funds and exchange-traded funds (ETFs) have underperformed significantly because of fall. Going forward what should be the best way if you have to give some part of your portfolio to gold. Would you still prefer e-gold or rather ETF gold funds or would you recommend physical gold? A: The reason we planners recommend any particular asset class is not because of its past performance or the current momentum. We look at an overall portfolio. Debt and equity generally as an asset class has an inverse relationship. So, when equities are doing well debt is not and when debt is doing well equity is not. Gold does not have any direct correlation so to that extent it acts as a balancing factor. Therefore, in overall portfolio gold as an asset class whether one does it directly or through physical gold or through mutual fund, it will act as a balancing factor. Therefore, to buy physical or gold ETF, will depend from case to case, for example in this caller’s case if she is looking at gold from marriage perspective and is going to happen in next one-two years then she should look into physical gold. Any investor looking at putting in money in gold for next two-three years then look at physical gold because that will be required in marriage or anything else. If it is a long-term gold ETF because the investor will get tax benefit, he will be saving the hassle of physically storing it and he will also get tax benefit. Therefore, it depends on what one wants to do but gold should be part of overall portfolio and look at overall portfolio as one single unit rather than each asset class separately because at any point of time one will have some assets going up and some assets going down.