Bank FD rates low? Invest in listed bonds

NEW DELHI: Banks are continuing to slash fixed deposit (FD) rates, putting pressure on those who survive on interest income. For instance, SBI has cut FD rates to 6.6% for senior citizens and 6.1% for others as of 10 January. Big private banks are also not offering much more. The highest interest rate offered by HDFC Bank is only 6.9% for senior citizens and 6.4% for others.
Though FD rates are low, yields on listed bonds from quality companies are at higher levels, providing an opportunity for savvy investors. Unlike FDs, buying bonds can be complicated. Therefore, the investors can filter their needs based on the following factors.
Risk
The first factor to consider is your risk taking ability. This is because several bonds from companies like Dewan Housing Finance, Reliance Home Finance, etc are now trading at very high yields. Don’t be in a hurry to buy though. “Investors should understand that high yields are due to the risk involved,” says Anil Rego, founder & CEO, Right Horizons.
Retail investors, especially those who want to shift from bank FDs, should steer clear of low-quality papers. The bonds from several high quality companies are now trading at a yield of 8.5% or above. “Retail investors should consider investing in taxable listed bonds with AAA rating now because the return gap between safe bank FDs and AAA rated bonds is almost 2%,” says Deepak Jasani, Head of Retail Research, HDFC Securities.
Tax
Taxation and tax slabs should be considered next. Listed tax-free bonds are good options for people in the high tax brackets. The yields on tax-free bonds are now in the range of 5.6-5.9%. “Since the pre-tax yields on tax-free bonds are now at around 8.5% for people in the 30% tax slab, it is the best option for HNIs,” says Rego. Since these bond issuers are highly rated public sector undertakings, the risk is also very low.
Liquidity
Most banks allow immediate withdrawal from FDs, but you can’t do the same with listed bonds. For liquidating your investments, you need to sell these in the market and money is credited to your account only after a few days (payout day). Another issue is all these listed bonds are not traded frequently. “While investing in listed bonds, investors should be careful with liquidity. You may get into trouble if you buy bonds with low liquidity and want to sell them before maturity,” says Rego. Spreading purchases and sales is another option.
Consider bond ETFs too
Buying into listed fixed duration bond funds is another option. Since the 20% long term capital gain tax here is levied after indexation, the tax liability will be low. For instance, let us assume that one of these ETFs generates a return of 7% for a 3-year holding period and the inflation during the time is 4%. Since the 20% tax is applicable only to the inflation adjusted returns—3% in this case, the post-tax yield will be 6.4%.
Though there is enough liquidity in the recently introduced Edelweiss Bharat Bond ETF counter, experts are concerned that the scheme is not yet fully invested. However, the fund house says this issue has been resolved.
The main advantage with these listed ETFs is that you can time the market based on its running yields. The default risk is not applicable for these ETFs because all these schemes are based either on government securities or with AAA rated PSUs.