Monday, April 12, 2021

On Debt Investments

Was just going through the category-wise performance of mutual funds over the last five years.

Across all categories of debt funds - short, medium and long durations; or  dynamic bond  \ corporate bond funds, the five year CAGR ( Compounded Annual Growth Rate) is very close to 8 percent. 

In other words, there is no additional return for additional risk.

This is a good validation of what is obvious about the debt market in india, and, to reiterate:

Choose only the lowest risk funds. Additional risk is not worth it.

Lowest risk means any of the following:

1. Short duration, ultra short duration, and liquid funds. The credit risk is lower due the lower tenor, and there is no interest rate risk either since they are such short-maturity instruments.

2. Banking and PSU funds, not because the companies are anything great, but because mai baap sarkaar will not allow them to default. But watch out, these funds also invest in scrips like Yes Bank sometimes.

3. Government Bond funds, where the credit risk is zero (by definition, and not because we trust the sarkaar - never trust the sarkaar is a good motto to follow :-) ). But these funds typically play on duration. In a scenario where interest rates are moving up, you could be exposed to interest-rate risk. 

Always hold debt funds for more than three years. That way, you get the benefit of indexation and of the special rate of 20 percent, making the effective tax rate close to five percent or thereabouts.

Fixed Deposits yield similar returns as debt funds.

Bank FD's are: 

1. Counter intuitively , inherently riskier than debt funds, due to lack of diversification.

2. Wherever you get more rate ( say Cooperative bank) is exactly where you should not invest :-)

3. Banks are the riskiest places on earth as far as parking your money is concerned, but again mai baap sarkaar to the rescue, they will not allow the big  banks (public sector banks, icici, hdfc and a handful of others only) to collapse - the illusion of stability of that piece of Maya called economy requires banks to be kept alive even if in coma.

4. FD's are tax inefficient. Hugely so. It is only fine for someone whose income from other sources is not much. FD's are ok up to an amount of  say seventy to eighty lakhs, since the interest earned annually on that amount will fall  in the zero or lowest tax slab.

PF, PPF and Voluntary PF are always good options in debt too. UHSP's (ultra high salaried people) were taking advantage of mai baap sarkaar by investing huge amounts in VPF. Even without 80C benefit, they were earning 8 plus percent, tax free, with sarkaari guarantee. It was too good to last of course - auntie FM, who cannot tolerate to see anyone happy, plugged that loophole in the last budget. A couple of my UHSP friends went on a drinking binge after the budget (in a star hotel of course), they were so depressed. I commiserated with them in return for free booze.

To summarise: 

In the Indian market, debt is priced such that taking higher risk does not yield higher return. So, stick to safe options, when it comes to Debt Mutual Funds.

When it comes to Bank FD's , stick to public sector banks, and / or the top private sector banks. Also, for tax reasons, if you have other sources of income, avoid FD's altogether.
And, unless you are very very sure about the company / promoter group, avoid investing directly in corporate deposits. They also have the additional disadvantage of being tax inefficient, since their tax treatment is the same as that for FD's.

I was about to end  saying  Happy Investing, but there is nothing happy about investing nowadays.

So, park your money, grit your teeth, and hang on. Acche din zaroor aayenge!

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