The Hindu Business Line : Don’t lock into any long-term debt now

If you are an equity investor who can stomach some risk, you can certainly consider fixed deposits of corporates. But public provident funds should continue to be among the favoured options.

Vidya Bala

Investors looking for long term debt options would do well to wait it out rather than park their funds in avenues that yield a mediocre pre-tax return of 5-7 per cent today. The current interest rates may be challenged by inflationary pressures a year later, which in turn can reduce your “real” returns to a measly 1-2 per cent.

Field day

A year ago, investors were flooded with a myriad of debt investment options with attractive returns: bank fixed deposits offering special interest rates as high as 12 per cent, mutual fund fixed maturity plans with indicative yields at 8-10 per cent, non-banking finance companies as well as corporates announcing debenture options and deposits with yields anywhere between 10 and 13 per cent.

To add to the bonanza, gilt funds/long term debt funds that invested in long-dated government securities also yielded stellar returns as the bond yields crashed post September 2008, prompting a smart bond price rally. These attractive options were available even in the first couple of months of 2009, after which interest rates have been steadily moving downhill.

Current scene

Banks deposits: Today, bank fixed deposits offer a tame 6-7 per cent for one year term deposits and an average 7.5 per cent for a tenure of 2-3 years. Most banks have also closed their special deposit window as the high rates are no longer viable for banks, given that they also lend at lower rates now.

Debt funds: On the mutual funds side too, prospects for long-term debt/gilt funds appear uncertain what with bond yields steadily climbing since January. While the one-year returns of these funds look enticing, most of the medium to long term gilt funds have delivered negative returns over the last six months, with the best in the category delivering about 4 per cent over this period.

FMPs: Fixed maturity plans offered by mutual funds have also dwindled in number and offer up to three-year maturity. While FMPs no longer indicate the yield that investors can expect, the debt portfolio in which they plan to invest currently offer 4-7 per cent returns. Of course, while corporate fixed deposits may offer slightly higher yield, FMPs are unlikely to take higher exposure to such instruments given their higher risk profile.

Corporate deposits: This leaves corporate fixed deposit as the only option offering 9-12 per cent for a 2-3 year period currently. Needless to say, those that offer very high rates do carry high risks in terms of their business or debt to be serviced.

Where to invest

Interestingly, just about the time when debt lost its sheen in early 2009, equity markets took the baton to embark on a rally that could well have made up much of the losses incurred last year. However, this does not mean that one has to now turn overweight on equities.

If you had initially planned your portfolio with a certain proportion of equity and debt, you should continue to maintain the ratio. But with very few debt options what should you do?

Here’s what: If you are an equity investor who tracks companies and can stomach some risk, you can certainly consider investing in the fixed deposits of corporates. However, this calls for some active research about the company’s business, financials, its past track record of debt servicing and the rating it has received from credit agencies.

Remember, that unlike bank deposits, corporate fixed deposits do not have any insurance; you can lose your money if the company is too stretched on its debt burden. Having said this, companies with a good track record do offer steady returns for those looking for regular sources of income.

Corporate deposits are however, not recommended for investors unwilling to go that extra mile. They can instead, look at short-term debt funds and Monthly Income Plans (MIP) offered by mutual funds. Look for funds that have a track record of at least three years and have delivered not less than 15 per cent over the last one year.

These funds would provide you with sufficient liquidity and help you make quick switches if interest rates move six months to one year down the line.

You may not have to actively track bond movements to catch an uptrend. Announcement of deposit interest rate hikes by banks may be a good indication. Look out for such offers especially post March 2010.

While senior citizens can invest in mutual funds mentioned above, they would do well not to depend on the dividend for their monthly living expenses. Post office senior citizens’ scheme remains the best bet to meet one’s income needs. Other savings options such as employee and public provident funds should continue to be among the favoured debt options for those looking to build wealth.