Though finance minister has announced issuance of tax free bonds in FY 15-16, it makes sense to buy bonds from secondary market. Listed bonds are expected to offer double digit returns which should make them better investment opportunity.
Synergee Capital Services
Post parliament election and interim budget for the year 2014-15, there was rally in tax free bonds. The debt market was expecting a reduction in interest rate and in the interim budget, there was no announcement for any new tax free bonds. As there was no supply of fresh tax free bonds from the government, that ensured that the prices of these bonds in secondary market went up quickly. In last one year the bonds have given an annualised return of 25-30%. This return comprises of 15-20% premium and balance 8-9 % by way of tax free interest.
In the recent budget for the year 2015-16, the finance minister, has made an announcement for new tax free bonds for infrastructure sector. As per the past track record, generally the tax free bonds are issued in second half of the financial year. The rate of interest depends upon the benchmark GOI rate at the time of issuance.
During 2013-14, the tax free bonds were issued at 50 basis points below the benchmark GOI. The rate of interest ranged between 8.00 – 9.25%, depending upon the tenure and credit rating of the PSU. The retail investor were offered 0.25% extra interest rate in comparison to HNI/Institutional investor. To earn additional 0.25% interest, the retail investor should not invest more than Rs.10 lacs in a particular tranche of a PSU. If we go by these earlier guidelines we can safely conclude that the tax free bonds issued this year will also be issued at much lower interest rates.
As of now, the ten year GOI is trading at 7.70% yield to maturity and the bond market is expecting a substantial rate cut in the financial year 2015-16. If the interest rates move down by 50 basis points in next six months, the yield available on the new tax free bonds may not be attractive – typically around 6.75%.
The tax free bonds of earlier issues are available in the range of 7.00 - 7.25% yield to maturity. This offers an investment opportunity with little risk for investors. Especially for high net-worth individuals who pay tax at 30% rate of tax, it makes a worthy investment. If one accounts for the existing premium on the bonds and the interest accrued so far these bonds are offering pre tax return of 10.00-10.35%. Compare this with bank fixed deposit rates that are ranging between 8.5-9%, and the investment opportunity looks even better.
Many investors may still argue that there are bonds and company fixed deposits that offer 11% rate of interest. However a point to note is they come with credit risk. The existing tax free bonds listed in the secondary market, are issued by government undertakings and are akin to sovereign debt. There is little credit risk involved. There is no point taking undue risks with unknown players to earn one percentage point more as compared to a government bond.
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