Change Over From Bank Fixed Deposits To Debt Mutual Funds

Change Over From Bank Fixed Deposits To Debt Mutual Funds

The 5 or 4 star rated, 100% debt-oriented mutual funds, are going to prove even better investments than bank fixed deposits going forward. This, particularly in the declining interest rate scenario, at present.

They are very safe, in fact more secure than the limited liability bank deposits, and generally hold a diversified portfolio of top-rated company debentures and government bonds to make up their portfolios.

Debt mutual funds in India now come in a wide array of choices: liquid funds that invest in very short-term debt instruments, often of just three-months duration or less; others are at short, medium, and long tenures, ranging from six months to 10 years.

When interest rates rise, the short term and liquid funds perform better, and when they fall, the longer term income funds produce better returns. For the foreseeable future, interest rates, as determined by the RBI, will keep going lower, for a host of reasons, not least of them being an urgent need to stimulate growth in the private sector, both manufacturing and services, enhance job formation,, and the moribund housing construction sector.

All debt funds, even the ‘close-ended’ ones, with a 3 year lock-in, are diversified, to contain, on average, between 10 and 20 different debt instruments. This is also in keeping with the regulatory environment, created by SEBI, mandated to protect the interests of investors.

The open-ended, growth option, debt mutual fund however, is the best bet for the retail investor, graduating from bank fixed deposits, because it can be bought or sold on any working day. Pay-outs are made direct to one’s designated bank account, within just three working days.

This means that even sudden, or planned monthly requirements, can be withdrawn at will, normally qualifying for no tax, and without having to wait for a taxable dividend applicable on 100% debt funds. This is unlike the tax free equity dividends, which are exempted, presumably for the greater risk undertaken.

And yet, Indians are wary, and stay away from investing in public limited company shares and debentures, traded in the stock markets, with direct and mutual fund investors making up less than 2% of the population. This absolute percentage has not changed over the years, even post liberalisation.

 All debt funds, by their very composition as fixed interest instruments, do not go up and down in value dramatically, like shares.

They rule steady, and return anywhere between 5 to 10% per annum on average, depending on the category chosen, and are more tax efficient than bank fixed deposits.

The tax on their profits is capped at a rate of 20% at present. This, provided they are held for three years. Early withdrawals require the profits, which tend to be minimal, unless the sum invested is vast, to be added to taxable income from other sources, and taxed at the marginal rate applicable to the individual.

This, theoretically is at about 33% in the highest tax slab, except for the few declared annual crorepati earners, who’ve had yet another tax slapped on them lately by NDA finance minister Arun Jaitley.

However for most, this duration to qualify for long term capital gains on debt mutual fund investments was upped in 2014, also by Arun Jaitley in his very first full budget.

Before that, these debt funds were even more attractive, because, like equity, the classification changed from short-term capital gains on the profits, for tax purposes, after just one year, to long-term capital gains.

And these were taxed at a flat tax rate of 10% initially, which was increased to 15%, and finally, in 2014, to 20%, albeit on an indexable basis, just like proceeds from real estate/property sales.

The one year qualifier was extended to three, in 2014, but for securities held longer still, the inflation indexing benefits, quite often, ensure that tax calculations, eventually, end up either minimal, or at nil.

It is also permitted by the RBI to pledge these debt funds freely to any bank. An individual can pledge up to Rs 20 crores, and borrow up to 90% of their value, at a rate of interest pegged to the RBI’s lending rate scenario, currently in the range of 10.5-11%.

Contrast this with a ceiling of Rs. 20 lakhs maximum, per individual, against equity, usually at no more than 50% of the market value, at the time of pledging.

The scores of debt mutual funds on offer, are all rated by CRISIL ,Value Research, Economic Times, Moneycontrol, etc., provided they are 3 years or more old, to provide an adequate track record.

These star ratings, and their logic, even for those funds that are not yet mature enough, are all freely researchable on the Internet and are often featured in newspapers or on the business oriented news channels as  well. And though there are many financial advisers, both with the banks and elsewhere, it is quite possible to invest directly, thereby saving on brokerage and commissions.

Bank FDs, on the other hand, are taxed at the marginal tax rate from the start, and are earmarked for more at the time of filing one’s returns, by TDS too.

Till a few years ago, the Indian investor did not have the myriad options that are available today. But, unfortunately, despite tax and return-on-investment (RoI) advantages, the many mutual fund schemes, for 100% equity, hybrid ones with both debt and equity, and 100% debt, are all still grossly under-utilised.

In 1963, the government established the very first mutual fund, initially via the Reserve Bank of India (RBI). The Unit Trust of India established a monopoly with its one-trick pony named US- 64, and this ran on and on, eventually garnering about 11,500 crores off  about 2 crore small investors, and handing out above average dividends for years. This, till it came to grief in the late nineties onwards, and is now, sadly, closed.

US-64 was joined, in 1987, by other PSU bank mutual fund offerings from the SBI, Canara Bank, PNB, and so on. Then in 1993, private mutual funds with highly professional foreign partners, from the multi-billion dollar US MF industry, were also allowed into the country.

And though small, with a market capitalisation in the region of half a billion dollars in 1994, and no more than $ 2 trillion now, the stock markets were early movers, becoming automated in 1994-95.

Today, per statistics up to March 2016, there are 11,856 mutual fund schemes to choose from, all competing for investments, and provided by 43 separate fund houses. Collectively, they manage a seemingly large Rs. 106,30,921.82 lakhs, in retail/institutional/corporate investments.

Interestingly, of  all the listed stock in the bourses, the FIIs hold 10.45% of  the total, obviously from the liquid Indian company stock, while Indian mutual funds account for just 2.68% , and other Indian financial institutions hold another 5.32% of the traded shares.

After all this time since the liberalisation and financial markets opening up of the nineties, there are just 20 million demat accounts, and some 248 listed portfolio managers, serving a population of over 1.2 billion.

The real rub is in the fact that the mutual funds, and the total direct participation in the stock markets, represents a fraction of the personal savings of Indians. These stood at 22,124.14 billion in 2013, up from Rs. 20,547.37  billion in 2012, as per the Ministry of  Statistics &Programme Inplementation (MOSPI).

The International Monetary Fund (IMF), states that the Indian household savings rate was at its highest in 2011 at 34.7%. It was at 30.17% in 2014, is expected to decline to 28.35% by 2018, before rising once again to 28.6% by 2020.

But from any perspective, the savings rate, for an essentially low income country, is commendable. What is not so good, is the way most people save their money for notions of apparent safety and risk aversion.

That a very small percentage of Indians use the financial markets is probably also a consequence of inadequate market penetration on the part of the financial services industry, despite several 24x7 satellite TV channels, devoted exclusively to the subject. 

Moves are afoot on the part of the government to deepen the Indian debt market, and whatever has been done so far, has been eagerly lapped up by the FIIs, if not the locals.

The equity market too has seen a recent spurt in initial public offerings (IPOs), largely gone missing for a long time. With banks under- capitalised, and burdened by NPAs, the debt market becomes all the more important as a source of capital, particularly for small to medium business (SMEs). These need to borrow money cheaply in order to turn a profit and thrive.

The bigger companies too, and more importantly, the government of India, largely lives and grows on its borrowings from the equity and debt markets, Our debt market however is largely illiquid, and not very large, in international terms.

Great strides in modernisation, a mandatory deepening, and widening, is necessary over the course. Meanwhile, individuals could do themselves a favour by moving a greater proportion of their savings to the debt market, instead of letting them wither away in banks.

For: Swarajyamag

(1,519 words)

July 12^th, 2016

Gautam Mukherjee