Non-payment of dues by IL&FS to holders of commercial papers has spooked bond investors’ sentiment, especially for those who take the mutual fund route.
The risk-off sentiment comes after a prolonged period of investors getting into credit risk schemes that are focused on investing in high-yield bonds with relatively low credit rating, with expectations of better returns.
At the moment, interest rates offered on bank fixed deposits are not really attractive, and the risk associated with high-yield securities with relatively low credit rating is too high to make them attractive.
1. Low credit risk
Banking and PSU bond funds are mutual fund schemes that invest in bonds issued by commercial banks and public sector undertakings (PSU).
“Banking space has many good quality names. Investments in PSU bonds also come with minimal credit risk. A carefully built portfolio of bonds issued by banks and PSUs, offer a low risk investment option,” says Dwijendra Srivastava, Chief Investment Officer – Fixed Income at Sundaram Mutual Fund.
PSU bonds are seen as sovereign risk and mutual funds typically restrict themselves to buying securities issued by financially sound banks with high credit ratings.
“These schemes make a strong investment case for the conservative investor who is afraid of investing in bond funds after the IL&FS incidence,” says Abhishek Gupta, Founder and Chief Financial Planner at Moat Wealth Advisors.
2. Better post-expense yields compared to credit risk schemes
While investing, one should not limit their focus to only the risk involved. It is better to take into account risk-adjusted returns.
“The ongoing yields on the banking and PSU focussed debt funds look good and if deduct the expense ratios of regular plans, then the expected returns from these schemes are attractive,” says Gupta.
Let us try an understand this with an example. The table below shows that the net expected returns after adjusting for the relevant expense ratio of the scheme does not give any incentive to take on the extra risk taken by credit risk funds.
Net expected returns on direct plans of HDFC Credit Risk fund and HDFC Banking & PSU Bond fund are the same. If you are an investor in regular plans, you are expected to make more on the banking and PSU debt fund, ceteris paribus.
While the numbers change for fund houses, you should check if you are getting compensated for the extra risk you are taking on. If not, stick to low-risk products.
3. Better post-tax treatment than company fixed deposits
If you are a fan of investing in bank fixed deposits, you should consider investing in banking and PSU debt funds. The interest paid out on the bank fixed deposit is added to your income at a marginal rate of tax.
The profits on investments in PSU debt funds for more than three years are treated as long-term capital gains. They attract a tax of 20 percent post-indexation.
This makes investments in these schemes an attractive proposition, especially if you are paying income tax of 20 percent or more.
4. Low exit loads
Given the tax treatment, most investors invest in bond funds with a view to stay put for three years.
But if you fall in a lower income-tax bracket and want to play bond funds for the short term, you must check the exit loads.
Credit risk funds come with heavy exit loads for longer time frames. The banking and PSU bond funds, however, are lenient on this front. Some of them do not charge any exit load.
5. Play on interest rates
“Global growth is slowing down and the inflation in Indian economy is expected to remain benign. The interest rates may not go up,” points out Sundaram MF’s Srivastava.
If rates start moving downward after a year, banking and PSU bond fund portfolios are better positioned to offer you capital gains. That could be an icing on the cake, if it happens.
