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Sowmya Sundar

GONE are the days when you could just put aside some money in a corporate fixed deposit scheme and sit back while it earned a handsome return based on a two-digit interest rate. Now you need to manage your fixed income portfolio actively to earn half that.

Not only have interest rates dropped by almost four percentage points in the last couple of years, but secure corporate options are also fewer. No wonder a lot of money is flowing into bank deposits despite the low interest rates. In this context, what are the best fixed-income options available? And how do you allocate your surplus between the various schemes on offer?

Short-term schemes

In the short term, the choice is rather limited. One has to choose between bank fixed deposits, post-office term deposits, a handful of company deposits that offer a lock-in of six months to one year and short-term debt funds.

In the less than one-year time frame, debt funds and bank deposits are the best bets. Gilt funds have been outperforming debt funds in the past due to large trading gains. But as a substantial reduction in interest rates from now on is limited, such performance cannot be expected in future. Therefore, one can consider debt funds over gilt funds.

The interest rate risk is higher in long-term debt funds than in short-term debt funds. If you want to limit the interest rate risk, it would be better to settle for short-term debt funds. The yield on short-term debt funds is at least 100 basis points higher than those offered by bank deposits.

For instance, Templeton India short-term income plan, PNB Debt Fund and Alliance Short-Term Plan are a few options. A six-month deposit currently offers 5 per cent, on an average. A few banks, such as Centurion Bank, Karnataka Bank and Global Trust Bank, offer 6 per cent. Companies such as Saw Pipes, Jindal Strips also accept deposits for six months. Though the risk is high, one can invest a small portion given the shorter time-frame and attractive rates.

G-secs: Take the mutual fund route

Now, retail investors are allowed to invest in government securities. But investors may be better off taking the mutual fund route as it is easier and cost-effective. Also, one would require professional help to manage investment in G-secs. Therefore, it is not suitable for small investors. Even high net worth individuals can opt for the mutual fund route as they will benefit from professional management.

If you need liquidity to meet near-term commitments, you can consider a liquid fund or a money market fund instead of idling away cash in current accounts. These funds give the twin benefits of liquidity and returns.

The interest rate for a liquid fund is comparable to a term deposit but offer liquidity unlike term deposits.

From a safety perspective, bank deposits offer highest safety as deposits up to Rs 1 lakh are eligible for deposit insurance.

Taxation

Debt funds not only give you liquidity but are also tax-efficient. You pay only 10 per cent dividend distribution tax. Corporate fixed deposits, barring a few housing finance companies, are taxed at the slab rate applicable to the individual.

Interest from bank fixed deposits and housing finance companies is eligible for deduction under Section 80L up to Rs 12,000.

Medium-term options

In the medium term — one- to three-year time-frame — the choice is limited again. Apart from bank deposits and deposits of finance and manufacturing companies, one can also invest in post-office time deposits and ICICI infrastructure bonds. (This year, only ICICI has come out with infrastructure bonds so far. IDBI and REC are also expected to offer similar options later in the year.)

For a one-year term, the interest spread between top-rated companies and bank deposits is meagre. For instance, Sundaram Finance and HDFC offer 6.25 per cent for one year.

The interest rates on bank fixed deposits, on an average, are just 25 basis points lower at 6 per cent for the same period.

However, fixed deposits of companies such as Ashok Leyland Finance and Mahindra & Mahindra Financial Services offer better returns on a risk-adjusted basis for longer tenures.

Some of the high-yielding fixed deposits are TN Power Finance, Fenner, Ballarpur Industries, Birla Home Finance, Tafe, Jindal Steel, Escorts and Jubiliant Organsis. They also carry higher risk.

ICICI tax saving bonds for a three-year tenure are quite attractive for people who are eligible for Section 88 rebate. Others can avoid the scheme as the rates are comparable to a bank fixed deposit without the tax benefit.

Longer tenures

Long-term investors still have some good choices. The government small-saving schemes are the best bet among long-term instruments. There are still some instruments that yield good returns on a risk-adjusted basis. Despite the rate cuts in the recent Budget, small-saving schemes offer much higher returns than other instruments. NSC, PPF and POMIS not only offer higher returns but are also tax-efficient.

For instance, the post-tax yield on NSC works out to 12 per cent for people eligible for 20 per cent rebate. For those eligible for the 15 per cent rebate, the yield works out to 9.6 per cent. The interest rates are attractive even for a person in the 30 per cent tax bracket who is not eligible for a rebate.

For 2003-04, investments in EPF score over PPF, as the interest rate on EPF is 150 basis points higher than that in PPF. The interest rate for EPF is 9.5 per cent this year.

Other options are 8 per cent taxable government bonds, 6.5 per cent tax-free bonds, ICICI Regular income and tax saving bonds, US-64 bonds, and institutional bonds such as Nabard capital gain bonds, EPF and mutual fund floating rate schemes.

When constructing a long-term fixed-income portfolio, it is advisable to park a larger portion in small-savings schemes, as there is practically no risk element. If you are eligible for the Section 88 rebate and have exhausted the Rs 70,000 limit set for other schemes and insurance products, you can consider ICICI tax saving bonds.

Only infrastructure bonds qualify for the additional Rs 30,000 eligible for the rebate. At present, as no other option is open, one can consider ICICI tax-saving bonds.

For a high net worth investor, the 6.5 per cent tax-free bond is attractive. The rate is higher than that on an 8 per cent taxable bond, which gives a post-tax yield of 5.6 per cent. For investors in the high-income bracket, the Kisan Vikas Patra is the most attractive scheme, followed by POMIS. Once these limits are exhausted, one can consider the 6.5 per cent tax-free bonds and floating rate debt funds.

Floating rate debt funds protect you from any sharp erosion in the NAV due to an interest rate hike.

A floating rate debt fund invests in floating rate papers and hence readjusts the interest to the market rate, protecting it from a sharp fluctuation in the NAV. From a long-term perspective, floating rate funds would be a better bet.

Planning for retirement

If you are planning for your retirement, which could be as long as 20-30 years away, you can choose from the pension plans offered by insurance companies.

Moreover, an investment up to Rs 10,000 is eligible for tax benefits. This could be a better way to plan for your long-term goals such as retirement rather than investing in piecemeal.

Options for senior citizens

The greying population is the most affected due to the fall in interest rates. To give this niche segment of the population a better deal, most banks, finance companies and housing finance companies offer them at least 50 basis points higher than the market rates.

The Government has also introduced a new scheme — Varishta Bima Pension Yojana — for persons above 55 years of age wanting a regular pension.

This scheme offers an attractive interest rate of 9 per cent. But due to the long lock-in period (15 years) and lack of liquidity, it may not be suitable for all. Investors with limited funds and future commitments are better off not investing in the scheme or allocating to it a minimum amount.

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