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Where to invest: Tax-free bonds or debt schemes of MFs

The new 10-year benchmark government security is trading around 6.85%. The last time India had a sub-7% benchmark yield was in July 2009.

By: | Published: September 21, 2016 6:03 AM

From the savers’ perspective, we are in for challenging times in the fixed income market given the record low yields. The new 10-year benchmark government security is trading around 6.85%. The last time India had a sub-7% benchmark yield was in July 2009.

Yields on tax-free bonds, a popular category of investments for Indian savers, have also faced a secular decline over the last couple of years as they are issued in primary market at a negative spread over corresponding G-sec yields. Since April 2016 there has been no issuance in the primary market and yields on tax-free bonds have seen further decline in the secondary market. Currently, yields on most tax-free bonds range 6.25-6.35% (for tenors of seven years to 15 years). Occasionally, it may be possible to get some retail lots on the stock exchange up to 6.50% as well.

Since these bonds are listed, the capital gains from sale of tax-free bonds (if you do sell it before maturity) can be classified as long-term gains on completion of one year from acquisition, unlike in case of debt schemes of mutual funds where the holding period has to be three years. However, indexation benefit is not available for tax-free bonds unlike debt schemes.

Advantages of debt schemes of MFs vs tax-free bonds

If one considers a holding period of three years and above, tax-free bonds do enjoy a slight advantage as the interest income still remains tax-free completely. However, it also depends on what kind of debt schemes one is investing in currently. While most dynamic and bond funds have a gross yield to maturity (YTM) of 7.30-7.70%, there is a category of funds called credit funds which offer a gross YTM range of 7.90-9.50%.

Liquidity, in terms of ease of investing and redeeming one’s investments at any point in time due to unforeseen personal requirements or changes in market scenario, is one big factor which swings the decision in favour of debt schemes as also the array of choices and diversification available to take advantage of various types and tenor of debt securities that one wants to take exposure to. Investing in tax-free bonds in secondary market would require a demat account and also a basic knowledge about concepts like duration, YTM, computing cash flows of the bonds and evaluating their credit profile. Compared to this, ease of monitoring and professional expertise are the other advantages offered by debt schemes of mutual funds.

The writer is head, fixed income, Principal PNB Asset Management

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