How to choose the safest bond investments

In general, the main considerations while investing in fixed-income instruments for a short horizon are safety and assured (yet low) returns. We will limit our discussion to bank/corporate deposits, mutual funds and corporate bonds. There are other avenues such as small savings (i.e., post-office schemes), RBI Savings Bonds, Sovereign Gold Bonds, etc., but these are sovereign or quasi-sovereign, and hence the safety aspect well established.

Since interest rates have been reduced significantly by the RBI to bolster the sagging growth of the economy, returns have been lower for depositors. Since February 2019, the RBI has reduced the signal repo rate by 2.5 percent points and, accordingly, the rates offered on bank, corporate deposits etc. have been brought down by these institutions. Mutual funds deploy in market-traded instruments and yield levels have tended to go lower. The yield-to-maturity (YTM) of debt MF portfolios is lower today than what it was one or two years ago.

Highlighting the exceptions alone

Lower interest rates are a fact of life and have to be accepted by investors. If you opt for higher returns from a lower-rated instrument given by a company that’s not doing well, you are compromising on your safety.

Coming to the safety parameter, while defaults have happened in a few mutual fund exposures and some banks have been in trouble, by and large, most of investors’ money has been safe. When one untoward incident happens, there is considerable media discussion and coverage. Rightly so. But the timely maturities and repayments do not make it to the news.

Similarly, the amount of deposits in scheduled commercial banks is Rs 1.43 crore crore (INR 143 trillion). The quantum of AUM in debt MFs is approximately Rs 14 lakh crore. Of the Rs 143 lakh crore in bank deposits or Rs 14 lakh crore of debt MF AUM, the extent to which the depositing public has been impacted is on the lower side.

Taking safer options

What should you do? Prefer public sector and leading private sector banks to park your deposits. There are banks offering a relatively higher rate of interest, but the quality of assets of those banks would not be as good as that of leading banks offering lower rates. The much talked about DICGC cover of Rs 5 lakh per bank is available, but that would be effective only when the bank goes into liquidation. There are many cooperative banks in trouble – these are not in a position to repay depositors; cases are dragging on in the courts of law. As cases drag on and till liquidation is ordered by the court of law or the RBI, the DICGC cover is not effective. In other words, if the bank does not seem safe enough, rather than looking at the insurance of Rs 5 lakh, it is better to go for a leading bank where this coverage doesn’t matter.

Among corporate deposits, go for those rated AAA from known business houses with proven goodwill. Leading banks offer rates lower than AAA-rated corporate deposits, while there are other banks that offer higher interest. You can choose as per your comfort level.

Coming to mutual funds, the choice of the scheme depends on your investment horizon and the portfolio’s maturity. If your horizon is, say, one week or one month, you should invest in liquid funds. You can consider money market funds if your horizon is six months to one year. Portfolio credit quality is important; check for the credit rating of the underlying instruments. MF portfolios offer diversification; as an example, a liquid fund with a portfolio comprising Bank CDs gives you exposure to several banks. Another advantage of the MF route over bank or corporate deposits is that, even for a horizon of less than three years required for indexation benefit, you can set off losses you may have from other investments, with gains from MFs, for tax purposes. Carrying out a systematic transfer plan (STP) to an equity MF would work better when done from a liquid fund than from a bank savings account.

AAA-rated PSU bonds are the best corporate debt instruments. Private sector bonds rated AAA and thereafter AA-rated corporate bonds are the next in the list. You may limit your investments to AAA-rated bonds, or at most AA-rated bonds of known business houses with track record and pedigree. You should buy multiple bonds for diversification.