Think beyond fixed deposits when it comes to debt

When it comes to debt investors should think beyond conventional fixed deposits. Mutual funds offer a viable alternative to investors who are looking to invest in debt. There are various types of debt mutual funds that an investor can consider such as liquid funds, monthly income plans (MIPs), fixed maturity plans (FMPs), etc., all of which cater to varying time horizons.

Liquid funds offer the highest safety and invest in highly liquid and safe instruments such as call money, short-term bonds etc. The biggest advantage of liquid funds over conventional FD’s is that they are more tax efficient as interest on FD’s are taxable at normal rate where as dividends from liquid funds are tax free in the hands of the investor.

Fixed Maturity Plans as the name suggests come with a fixed maturity horizon and are close ended debt funds. These funds invest in bonds in line with the term of the FMP and hold them to maturity and hence do not carry interest rate risk. FMP’s are very similar to fixed deposits and can be considered as a direct alternative to FDs because of its tax efficiency especially for investors in the higher tax bracket. The Long Term Capital Gains (LTCG) on debt funds is 20% with indexation or alternatively 10% without indexation whichever is lower. FMP investors can also benefit from double indexation benefit which at times can lead to notional loss despite there being a profit. This loss can be used to offset some other tax liability thus doubly benefiting investors.

Monthly Income Plans are debt-oriented funds with a mix of equity and are ideal for people who need a regular income but at the same time are unwilling to take on big risk. The debt investments ensure stability and consistency while the equity instruments in the portfolio boost the returns and are thus market linked to the extent of the equity portfolio. MIP would make a good investment at this juncture for two reasons. One of the reasons being that majority of the funds are deployed in debt instruments. Bonds and interest rates have an inverse relationship and hence the hike in interest rates by the RBI would lead to fall in value of the debt instruments held by these funds and hence depressing their NAV’s. The interest rate cycle should turn going forward and when the RBI lowers rates the bond instruments would see appreciation giving a boost to the funds NAV’s. The second reason is that the equity markets have also been subdued because of the global uncertainties and domestic concerns such as persistently high inflation and regular hikes in policy rates by the RBI to tame inflation providing a double whammy for the NAV of these funds. Thus when the interest rate cycle turns and the global uncertainties settle down investors should benefit from the appreciation of both debt and equity. The only caveat being that investors should have a minimum two to three year investment horizon for investing in these funds.

Happy Investing

By Alok Basrur - Research Analyst - Concept Securities Pvt. Ltd.