Ladder7 Financial Advisories
The climate here in Mumbai is wonderful. It’s raining, it’s green everywhere & it’s a pleasure travelling… But lot of people sport a longface as if they have lost a couple of ships at sea - there are reasons, ofcourse…
Also read: Here’s why and how you should plan your retirement
After the capitulation in 2008, the markets have not recovered. Many are seeing measly single digit returns in their portfolios. Most found comfort in debt and on the way, in Gold & silver. But they found out that gold may glitter, but need not necessarily give returns.
After buying a lot of Gold, they found the gold prices tanking and that contributed to the drawn face too. Property has been doing well, but alas, most can only sit on the sidelines & despair as the prices have reached the heavens and Gods themselves marvel the stratospheric climb of the (un)real estate!
Debt Mutual Funds were offering reasonable returns and tantalised everyone with the prospect of Coupon + capital appreciation, in a potentially falling interest rate regime. The problem is with the word potential.
The truth of the dictum – if something has a chance to go wrong, it will - was brought home painfully to investors, by our note printing institution, to arrest the downward spiral of the rupee.
The rupee is none the better for RBI action. But the debt markets have been delivered a massive wallop. This is an example of action which benefits no one, but end up bulldozing a whole contingent caught unawares.
The debt funds, which were one source of solace for the public, turned into a leaky ship overnight. The yields have jumped in all debt instruments, the NAVs have gone down in tandem. And there was gloom all-round.
I said was… there is always a silver lining to every cloud and so it proved in the present instance too. Since the yields have spiked, MFs started offering Fixed Maturity Plans (FMPs), putting together the various instruments available that are offering high yields.
For instance, Certificate of deposits are offering about 10 percent yields for one year tenure and Commercial Papers are offering as much as 10.8 percent for the same. Yields for lower tenures are even better.
FMPs have suddenly become instruments of choice, for investing on the debt side. One year FMPs are offering about 9.6-9.7 percent pa yields, post expenses. Two and three year FMPs are offering 9.2-9.3 percent post expenses return (Returns mentioned here are purely illustrative only).
A major advantage for FMPs is the taxation treatment accorded to them. All debt MFs, including FMPs, come under capital gain treatment. For debt MFs, longterm capital gains kick-in after one year of investment. It is 10 percent without indexation or 20 percent with indexation. This offers tremendous opportunities for saving on taxes.
For instance, if one were to get 9.6 percent returns after a 365 day investment period and the inflation in the year was 8 percent, the actual taxable returns would only be 1.6 percent. Tax applies on this at 20 percent and works out to 0.32 percent.
Hence the return to the investor is 9.28 percent (9.6 percent - 0.32 percent ) post tax! The effective tax in this illustration was 3.33 percent only! Now, you would agree that it is a fantastic return which no other debt instrument can offer.
The second major advantage of FMPs in this volatile situation is that the instruments being put together for the FMP will have tenure equivalent to FMP tenure itself. That means the yield at which they have been locked-in, will accrue to the investor.
Any fluctuation in the interest rate regime in the meantime, does not affect the FMPs. This is a major plus in the current situation.
A word of caution though - FMPs have no liquidity, for all practical purposes. FMPs are listed on the stock exchanges, but are seldom traded. The liquidity they wanted to create for FMPs is only on paper. Hence, be prepared to stay invested for the tenure of the FMP.
Is there any other investment theme that investors can take advantage of?
There are ultra short-term funds, where the yields are very good now as short-term paper yields have gone up. To sweeten this a bit more, some of them have implemented an accrual strategy in their funds.
This means, they will buy and hold the papers till maturity and investors will get the yield, when the papers mature. The fund continues to be an open ended fund, thus giving the benefit of liquidity for those who need it and good returns for those who stay on.
Ofcourse the tax treatment for less than one year investment will be at one’s income tax slab rates. But then the post-tax returns from these instruments will be far higher than FDs of short tenures and have the additional advantage of liquidity, without penalties.
Hence, it still makes immense sense to maintain the liquidity/ contingency margin needs in a liquid fund rather than in savings account or shortterm bank FDs
If one is clear that the funds invested here are for the short term ( less than a year ), it is better to invest in dividend option as the effective taxation ( by way of Dividend Distribution Tax ) is 28.33 percent.
This is better for those in the highest tax bracket. If one is in the lower income tax brackets or there is a possibility that the funds may remain for long without it being used, growth will be a better option ( in view of the longterm capital gains treatment, after one year ).
What about other debt funds?
Should they stay invested in debt funds is the question uppermost in the minds of investors now. They also want to know if they can invest more money in debt funds now.
RBI action taken at this point has impacted growth and stoked inflation. Both of these are high concern areas for the economy today. So RBI has to reverse course sometime in future and go further on the journey downhill for interest rates. When that happens, the debt funds will again see capital appreciation.
Since there is a NAV erosion now, if one invests with a tenure of 2-3 years in mind, one can capture the beneficial effect of the interest rate reduction cycle. Hence, it is actually a good time to invest in debt funds for good returns, if one has time on their side.
I do hope I have brought some balm – zandu balm, for the Bollywood aficionados – for all those with a pain in the solar plexus. Now if you get wet in the rain or see a nice green patch, don’t wince thinking of what might have been.
Count your blessings, one by one. Even if their number & frequency has reduced, atleast they are still coming!