Time To Move On From Bank FDs

Time To Move On from Bank FDs

It is impossible to produce superior performance unless you do something different from the majority- John Templeton

India has a household savings rate of around 30%, even though it is a relatively low-income emerging economy. Despite this, only 2% of the population participates in the stock market, including the debt market.

This counts the investors on a direct basis, and those via mutual funds too. And this, from a population of over 1.2 billion.

While this percentage has not changed, even after the liberalisation of the economy from 1991, it may be time for more people to to reconsider, and use the debt market more, without having to take on any appreciable risk in the process.

The 5/4 star rated, 100% debt-oriented mutual funds, are going to prove better investments than bank fixed deposits going forward. This, particularly in the declining interest rate scenario, being promoted vigorously by the finance minister at present.

The time lines to this policy direction may become clearer once the new RBI governor gets his or her feet under his Mint Road table.

 All 100% debt funds hold a diversified portfolio of top-rated company debentures and government bonds to make up their number. And they 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 grinding lower, alongside other measures to improve the liquidity in the financial system.

The policy need to cut interest rates stems from an urgent requirement to stimulate growth in the private sector, both manufacturing and in services, enhance job formation, and wake up the moribund housing construction sector.

Others who will be glad, the home-loan borrowers, car/appliance/student loan availers, the SMEs, consumers, start-ups,  business/industry that wants to add capacity, and so on.

 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. These can be bought or sold on any working day. Pay-outs are made within just three 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.

All debt funds, by their very composition as fixed interest instruments, do not go up and down in value dramatically - like shares do. They rule steady, and return anywhere between 5 to 10% per annum, depending on the category chosen, but are certainly more tax efficient than bank fixed deposits.

The tax on their profits is capped at a rate of 20% , 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 .

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 the NDA.

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 end up at nil.

So, a debt fund investment held, say, for 10 years, and now worth more than double with the compounding effect, will compute as tax free on withdrawal, because of  the indexation feature. Of course, the law/provision could change, as it has in the past.

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 the debt securities value, at a rate of interest pegged to reference the RBI’s lending rate, revised from time to time. Current costs are in the range of 10.5-11%.

Contrast this with a ceiling of Rs. 20 lakhs maximum, per individual, against equity, no matter how much there is to pledge,  at no more than 50% of the market value, with a commitment to make good any precipitous drops in value within 48 hours.

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

Their star ratings, reviewed monthly or more frequently, and their logic, even for those funds that are not yet rated, are all freely researchable on the Internet, in newspapers/specialist magazines, or on the business oriented news channels.

And  though there are many financial advisers, both with the banks and elsewhere, it is quite possible, for those with a knack for finance, to invest directly, thereby saving on brokerage and commissions. This is well worth it, and could improve the yield by half to a full percentage point.

Bank FDs, on the other hand, are not only static once one they are locked into a return stated at entry, but taxed at the marginal tax rate from the start.

Today, per statistics up to March 2016, there are 11,856 mutual fund schemes to choose from, provided by 43 fund houses. Collectively, they manage Rs. 106,30,921.82 lakhs, in retail/institutional/corporate investments in n all categories- equity, hybrid and debt put together.

Mutual funds, plus all the direct participation in the stock markets, represent 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), meanwhile, states that the Indian household savings rate was at its highest in 2011 at 34.7%. It was at 30.17% in 2014.

Moves are afoot on the part of the government to deepen the Indian debt market. Whatever has been done so far, has been eagerly lapped up by the FIIs, who invest more in Indian debt than they do in equity.

With our PSU banks under-capitalised, and burdened by NPAs, a developed debt market will become all the more important in future as a source of capital.

The SMEs certainly need the debt market, but so do the bigger companies and most importantly, the Government of India. The government largely lives and grows on its borrowings.

While overall, our stock market capitalisation does mirror the size of the official economy, our debt market is still, when it comes to government gilts, for example, largely illiquid. And, despite some reform undertaken, not very large, in international terms. Great strides in modernisation, and a great need to ramp up of capacity will  have to be addressed.

It is certainly a case, for those in the know, that a developed financial market, can, and does, receive many multiples of the FII investment that India is able to attract.

The international investment portfolios run into more than $35 trillion per annum. So the sky, indeed the stratosphere, is the limit - considering India receives less than $50 billion, all told, at present. Moving some of our fairly impressive domestic savings from FDs and their ilk, into debt funds, could be a start in the right direction.

For: The Sunday Guardian

(1,278 words)

July 13^th, 2016

Gautam Mukherjee