However, investors have been timid in leveraging the new investment options. Bank-term deposits and small savings schemes continue to account for a substantial proportion of their total investments in debt instruments.

Investors have still made money although they would have gained more had they opted to invest in actively managed mutual fund schemes.

Robust real returns

Nominal return is an ineffective way of measuring the performance of debt investments. A better measure would be the `real' returns. Simply put, real returns are the excess of nominal returns over the rate of inflation. In the later half of the last ten years, investors have been able to earn robust real returns. Only the real return matters as only that can add to purchasing power.

For instance, an investment in a ten-year bank term deposit in 1993, would have fetched a return of about 10 per cent. In the ten years between 1993 and 2003, inflation (as measured by consumer price index for urban non-manual employees) rose at a compounded annual return of about 6.85 per cent. This would have given investors a real return of about 3.8 per cent.

For bank term deposits, the real rate of return between 1994 and 1998 was low; it hovered around the 1.5 per cent mark across maturities. Thereafter, the consistent decline in the rate of inflation ensured that investors earned high real returns.

For maturities between one and five years, real returns ranged between 4.5 per cent and 5 per cent. This can be considered exceptionally high.

Important, bank term deposits was probably the worst-performing debt investment in the past decade. Those who opted to invest in small-savings schemes or actively managed mutual fund schemes would have earned significantly higher returns. Of course, there were unfortunate incidents.

Investors got to learn what credit risk meant, the hard way. In 1997, several non-banking finance companies, mutual benefit funds and plantation companies went bust.

The default by this section of the financial industry would have caused untold misery and robbed investors across the country of more than Rs 1,00,000 crore. Safe and prudent investing was, however, rewarded handsomely.

Rewarding tax changes

Safe and prudent investing through mutual funds and insurance companies were rewarded through appropriate tax laws.

Taking away tax sops

Changes in tax laws were at times unfavourable. Tax rebate was totally done away with for people earning more than Rs 5,00,000 per annum.

Stiff challenges

Now, there is a disproportionate increase in the challenges facing a typical fixed-income investor.

Interest rates are at an all-time low. Inflation has not been conquered and there are ominous signs that real returns could decline sharply.

It is increasingly clear that the returns for an unplanned, passive investing in a variety of debt instruments would not be able to satisfy the needs of an investor.

Investors may have to wean themselves away from bank-term deposits and opt for embrace mutual funds investment options wholeheartedly in order to generate better returns.

This is because the tax-efficient mutual funds appear better placed to take advantage of both the opportunities and the complexities of fixed-income investing.

They may have no better choice than opting for to secure exposure to the emerging income-enhancing options such as interest rate derivatives, asset-backed securities or a broadening or deepening corporate bond market.

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