Debt as an asset class gives stability to your portfolio and also helps in periodic asset rebalancing.
Diversification is the soul of investing. Those who invest in pure equity should diversify across different asset classes — debt being the other major asset class. Debt as an asset class gives stability to your portfolio and also helps in periodic asset rebalancing. A few incidences of failure of some companies to pay at the time of maturity of their papers have made investors and fund managers of debt funds very cautious and more careful.
While investing in any debt product, safety, liquidity and lower volatility are of paramount importance. For those who seek these elements can consider investing in PSU bond funds. In this article I wish to discuss one such product i.e. Funds based on Nifty PSU bonds plus SDL Sep 2027 60:40 index, which offer all these benefits in debt investments.
What is Nifty PSU Bonds Plus SDL Sep 2027 60:40 Index
The National Stock Exchange issues indices from time to time in the equity as well as debt category to help the mutual fund houses to replicate the same and investors get an assurance about indicative returns. In the month of September 2021, NSE has notified an index in the debt category “Nifty PSU Bonds Plus SDL Sep 2027 60:40 Index”. This index comprises two parts. One part constitutes of AAA-rated bonds of 8 Central government companies and the other part has loan papers of top 20 state and Union Territories. The first part has 60% weightage whereas the second part of state development loan has the remaining 40%.
All the bonds and state loans will mature within a period of one year prior to the 30th September 2027. So effectively the duration of any fund which replicates this index will have six years. Considering the fact that constituents of this index are AAA rated bonds and top states, the credit risk of investing in fund based on this index is almost eliminated.
Product available for investors replicating this bond and SDL index
In order to provide investors the safety of their debt investments and assurance about the indicative return, ICICI Prudential Mutual Fund has launched an index fund which will be benchmarked against the above NSE notified index. Since the fund proposes to retain the securities till its maturity, the investors can be assured of the indicative return of 6.28% if the investor holds his investments till maturity irrespective of any change in the interest rate in intervening period. Though the fund has a fixed maturity date of 30th September 2027, the fund is not a close ended scheme. Therefore in addition to providing security and interest rate assurance, it also offer investors much needed liquidity because an investor can redeem his investments any time after the initial lock in period of 30 days. This feature makes this fund very attractive. The fund will mature on 30th September 2027.
Investing in debt funds is more tax efficient than any other debt product
All bond funds including the funds replicating the above PSU bonds and SDL index are treated as debt funds for taxation purposes. Investments in debt fund becomes long-term capital asset after it has been held for more than 36 months, else it is treated as short term capital asset. Profits on sale of short term capital assets are treated as short term capital gains and such profits on debt funds are taxed like your bank fixed deposits at your slab rate. However, the long term capital gains on such bond funds enjoy twin benefits which make them very tax-efficient, especially those in the higher tax slabs.
Firstly, you are allowed to apply Cost Inflation Index (CII) to your cost of purchase to compute your taxable long-term capital gains, and the other benefit is that such long-term capital gains after indexation are taxed at a concessional rate of 20% against the maximum marginal rate of 30%. The tax efficiency can be appreciated with the help of a hypothetical example. Assuming you had invested Rs 1,000/- in both the products: bond fund offering 6.30% and the bank deposit six year ago i.e. in 2015. Based on the actual CII announced by the government in the past, the effective post tax returns on your bond fund are higher at 5.28% against 4.60% on bank FDs. In relative term, the post-tax returns of bond funds are higher by 26.37%, which is very significant.
So, in case you are in higher tax slabs or want to have funds available after six years and do not wish to take the risk of default and interest rate risk, the funds replicating the PSU Bond and SDL offer an excellent investment opportunity.
(The author is a tax and investment expert, and can be reached at email@example.com)