How to choose fixed-income assets

Amit KukrejaWealthbeing Advisors

The equity markets have not been impressive over the period of last 4 years; the upcoming elections may not give us a stable government; inflation & account deficit have been difficult to tame. Investors are nervous and subsequently resorting to increased exposure to fixed income assets. And when they look around they find that there is plethora of fixed income assets to choose from. It was never so confusing for the investors to make their fixed-income portfolio decisions. Let us look at some of them and also their suitability for people: Government backed fixed-income products: Fixed income products like Public Provident Fund, Post Office Monthly Income Scheme, Senior Citizen’s Savings Scheme, Employee Provident Fund, National Savings Certificate etc. have stood the test of times. They have delivered returns as promised. Given their government backing, the risk they carry is very low. You can always choose them in your portfolio after understanding their lock-in period, liquidity constraint, rates of return and taxes on money earned in them. Also the exemptions under section 80C for contributions made to them cannot be ignored. Only EPF & PPF are exempted from tax during contribution, accumulation and distribution phase. They are a good fit for your portfolio if you still have a working life to look forward to. Products like SCSS and PO-MIS make sense for people who are looking for periodic incomes and safety of capital with minimal risk.

Corporate & Bank Fixed Deposits: Bank fixed-deposits are the favourites in our country. People don’t realise that fixed deposits are not always tax advantageous. Sometimes to protect the capital they go overboard with fixed deposits and end up earning interest that becomes negative rate of return after accounting for inflation. Corporate fixed deposits may promise higher returns. They may give better pre-tax returns but the risks they carry are more than bank fixed deposits. These FDs need to be supported by strong financials of the company. Sometimes it is difficult to verify company’s financial strength unless they are publicly listed and have their financial data available. Fixed deposits are suited for investors who are looking for parking their money for a short term. People who are in low income-tax bracket can also invest in fixed deposits that should give their returns some tax relief.

Tax Free Bonds: These products have been very popular this season. Tax free returns upward of 8.5% are mouth-watering. This comes out to be anywhere between 8.5% to 12.70% pre-tax returns on your investment depending upon your income-tax bracket. These bonds can be traded in the markets. If an investor has a diversified portfolio and is looking for a tax free income for next 10 to 20 years, tax free bonds fit the portfolio very well. The bonds chosen should be the ones rated highly by the rating agencies, with minimal risk in issuing company’s financials.

Debt Funds: Debt funds have been there for a long period now. They are relatively low risk (compared to equity funds) and have lower tax liability when compared to other fixed income assets. But don't assume any mutual fund debt product as a pure fixed return instrument. Debt funds do carry the risk, some more than others. You could lose money here too. Intrinsically, debt funds hold debt instruments of a fixed tenure and a fixed return. In that sense, they are assured. However, once you invest in them other factors like interest rate movements, the fund manager's call on their direction, his/her trading skills and also the intrinsic quality of the portfolio play an important role. Some popular debt funds are Income funds, Liquid Funds, Long & Medium Term Funds, Short Term Funds, Ultra Short term funds, Gilt funds. They are suited for people whose financial goals are not too far that would need the money. Their tax incidence is better than fixed deposits. Their liquidity convenience is better than fixed deposits, government backed fixed income assets and tax free bonds. They carry more risk however they can give returns better than their fixed-income peers.

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FMPs: Fixed Maturity Plans are close-ended debt funds. They have been delivering decent returns if their holding period spans across financial years. Given the last quarter of the financial year, several FMPs are launched where the holding period pans across couple of financial years. Since these are financial assets they give us indexation benefit while calculating taxes. They protect an investor from interest rate volatility. They can be traded on exchange. The plans are not devoid of risks they do carry with them credit risk, interest rate risk & liquidity risk as any other debt fund does. In a recent study on returns, CRISIL noted FMPs gave better returns than FDs of one to three years, with 92 per cent beating FD returns over a similar time frame. If you are looking for parking your money for a short to medium term with a lock-in and tax advantaged returns, FMPs are must-have candidates in your portfolio.

We have so many products to choose from fixed-income space but you must understand that it’s a diversified portfolio that gives an advantage. Given volatility in the equity markets in last 3 months, it is indeed an opportunity to continue or start SIPs in diversified equity funds. Even though the four year returns of the average large-cap equity fund stands at 6-9% however regular SIP over the last four years have generated returns close to 10% and these are through difficult times. In the long run equity markets have given inflation beating returns along with tax advantages.

Ensure you have a balanced portfolio based on your age, life-stage, risk profile, asset allocation strategy & macro-economic factors. Do consult your financial advisor if you are unable to arrive at the right investment strategy.

- Amit Kukreja The author is the founder of WealthBeing Advisors and a member of The Financial Planners’ Guild, India (FPGI). FPGI is an association of Practicing Certified Financial Planners to create awareness about Financial Planning among the public, promote professional excellence and ensure high quality practice standards.