As reported by the Economic Times of India: Debt investors should now make some changes in investment plans after the Budget to maximise their returns and make them more tax efficient. According to investment consultants, dividend options of short-term bond funds are not more attractive as compared to fixed deposits. It is time to increase exposure to long-term gilt funds.
“It is time to invest in long-term gilt funds with 12 to 18 months time frame and move out of the dividend option of debt funds due to increase in dividend distribution tax,” says Vikram Dalal, managing director, Synergee Capital Services. The finance minister has raised the dividend distribution tax (DDT) for debt funds to 25% from 12.5%, making them tax unfriendly. Finance minister’s promise on containing the fiscal deficit at 5.2% has given hopes to a possible rate cut by the Reserve Bank of India (RBI) in the near term.
Falling interest rates are beneficial to long-term gilt funds because of the inverse relationship between the price of a bond and its yield. “Realistic fiscal deficit numbers have actually given more headroom to RBI to reduce key rates in this financial year,” says Pankaj Jain, senior fund manager — fixed income, Principal Mutual Fund. Other macro economic variables also support the need for a rate cut. India’s WPI Inflation is on the way down — 6.62% in January 2013, compared to 7.18% in the previous month.
The economy continues to slide – as India’s GDP growth for the third quarter of FY2012-2013 stands at 4.5%. These set the stage for a cut in key rates by the central bank on March 19 in its mid-quarter monetary policy review. Pankaj Jain expects key interest rates to fall by 50 to 75 basis points before March 2014, in a phased manner. Vikram Dalal says, “You can expect double-digit returns from long-term gilt funds. But remain invested in the growth option and avail of the indexation benefit to reduce your tax burden.”
He, however, prefers to stay away from long-term income funds to avoid the credit risk. In a slowing economy, the risk that a bond issuer may default goes up, which is not the case with government bonds. Experts believe investors, especially those in the higher tax bracket, should consider investing in tax-free bonds to enhance their returns. These bonds come with terms of 10, 15 and 20 years. “If you are in the highest tax slab, tax-free bonds offer good post-tax returns,” says Mukund Seshadri, founder partner, MSV Financial Planners. Currently, five public issues of tax-free bonds are on offer.
You can also consider laddering in these bonds – investing across various terms. As interest rates fall, prices of these bonds are expected to go up, offering you capital appreciation in addition to the agreed tax-free coupon. The longer the term of the bond, higher the capital appreciation it may offer if rates go down. In the next year too, the finance minister has allowed tax-free bonds up to a total sum of Rs 50,000 Crore.