HNIs turn to low-return products; tax-free bonds, FDs preferred choices

RBI bonds come with a lock-in of seven years from the date of issue and the interest earned is taxable
Risk-averse wealthy investors, who have pulled out money from credit-risk funds, are looking at a number of alternatives in the debt segment, notwithstanding the lower post-tax returns.

The options range from tax-free bonds, bank fixed deposits, and RBI 7.75 per cent savings bonds for the ultra-conservative to gilt funds, corporate bond funds, banking and PSU funds, and sovereign bond funds for others. 

“Investors have burnt their fingers in credit-risk funds and AT1 bonds of YES Bank and become risk-averse. The safety of capital has gained primacy over returns, which is why a lot of money has moved to products like tax-free bonds, RBI bonds, and even bank fixed deposits,” said Ashish Shanker, head-investments, Motilal Oswal Private Wealth. Tax-free bonds are issued by public sector entities and can be purchased in the secondary market. These bonds make sense in a declining interest rate scenario for those who are in the highest tax bracket, said experts. 

RBI bonds come with a lock-in of seven years from the date of issue and the interest earned is taxable. For those in the highest tax bracket of 42.7 per cent, the returns could whittle down to about 4.4 per cent. “Although you can buy and sell tax free-bonds in the secondary market, liquidity is always an issue. High networth individuals can look at corporate bond funds and banking and PSU funds, which offer better yield and liquidity,” said Rohit Sarin, co-founder, Client Associates. 

Corporate bond funds have to invest at least 80 per cent of their portfolio in AAA-rated papers. Some of the funds are now holding a 100 per cent AAA-rated portfolio, said experts. 

Such funds also offer a relatively diversified portfolio. “Instead of investing, say, Rs 1 crore in a tax-free bond of one PSU, the same amount can be invested in a banking and PSU fund, which invests across different PSUs and banks. On paper, the risk is the same but in reality, the risk is diversified,” said Sarin. 

 

 
Investment in gold through sovereign gold bonds has attracted investors as well. “Gold can be a good hedge in the portfolio in these uncertain times, and could gain traction in the next one year,” said Nitin Rai, chief executive officer, InCred Wealth.

Financial planners suggest not putting more than 5-10 per cent of one’s portfolio in gold. 

“Investors can look at staggered investment since gold prices are already at an all-time high. Prices may rally another 15 per cent in the next one year, but the moves can be volatile,” said Rao.
According to reports, 2.5 million units of gold bonds worth Rs 1,168 crore were sold in the May issue, the highest-ever amount mobilised by the government from the sale of sovereign gold bonds. The issue, which closed for subscription on May 15, was priced at Rs 4,590 per unit (one gram of gold). “This is a good option as one does not have to pay taxes if gold prices appreciate during the eight-year holding period. Plus, you get an interest per annum of 2.5 per cent on the amount invested (which is taxable). Even assuming price appreciation of 5 per cent and an interest component of 1.5 per cent after tax, investors can get 6.5 per cent per annum, which is reasonably good in this environment,” said Suresh Sadagopan, a financial planner. 

Sarin believes that while gold may deliver good returns over the next few months, returns over a five-year period can be muted. “Over the long term, gold gives slightly higher returns than debt, but it can be almost as volatile as equity,” said Sarin.  

Gilt funds are another category that investors are closely looking at. Such funds have given average category returns of 15-17 per cent in the past year owing to the steep cut in interest rates over the past few months. While most of the gains may have been priced in, investors still get mid-single-digit returns.  “Assuming no capital gains over five-seven years, investors can get post-tax returns of 5.7-5.8 per cent, making them attractive,” said Sadagopan. Long-term capital gains on debt funds are taxable at the rate of 20 per cent after indexation.


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