Over the course of the past one month, I received many more queries on debt investments than usual. If you think this happened solely because of the Franklin India debt fund fallout, that isn’t the case.
There were questions on buying gilts, gilt funds, going for Bharat Bond ETFs, buying bank AT1 bonds and why not fixed deposits in Yes Bank! The chief reason for all these questions is actually the low interest rate scenario prevailing in bank deposits and post office small savings scheme.
The search for higher rates has begun! But in the process, it is important not to choose options that are ill-suited to your risk profile.
Here are some points you will do well to remember:
Gilts may be unsuitable
If your objective is to get regular interest income through a buy-and-hold strategy of safe, government debt securities (called gilts), it not a good idea now. With gilts nosediving to under 6%, you lock into low interest now, just as you would lock into a long-term FD at low rates now. What people do in such scenarios is tactically play this, by entering when yields are expected to go down (and cause prices to rise) and exit with come capital gain when rates touch a low. But if you are not a bond market watcher who is ready to time investments, gilts will not help you at this stage. A discerning investor said he could overcome the need to tactically do this himself by choosing gilt funds as the fund manager would book some profits or enter opportunistically. True. Gilt funds can be good long-term options. But what he did not know is that gilt funds, too, can deliver negative one-year returns, when rates suddenly turn adverse. So, would the investor be willing to see some market-linked losses in his gilts (which he sees as a proxy to FD)?
Another investor told us that he was advised gilt funds as a six-month product and that he could generate 6% in six months. Now, I am not refuting the possibility of such returns in the current scenario. But what he was not told is that the gilt funds can be very volatile and you can lose capital if the interest rate suddenly moves up. Your FD would give you an assured return even over six months, but not so your gilt funds. They need a longer time frame to tide over such volatility and rate risks.
The same holds good for Bharat Bond ETFs too. They are quality papers of PSUs and their yields (current 10-year ETF at 6.81%) are better than gilts but there is no escaping price volatility. The question you need to ask yourself is whether this is the best return you can get if you simply hold for 10 years. And again, they don’t fit your bill for steady income or far higher returns, in the current low rate scenario.
Bonds and equity risks
With the search for higher returns came the risk appetite for AT-1 bonds of banks, once again. Many asked us whether investment into AT-1 bonds of ‘safer’ banks such as SBI or ICICI Bank are not advisable. Well, they are indeed less risky than other banks. But the issue lies in believing that these bonds are similar to FDs, when they are not.
AT-1 bonds are built to be part of the permanent capital for banks (like equities). They carry many terms that make them unlike a debt instrument. They can skip interest payment (and not carry it as a due), under certain conditions. They need not mature in five or 10 years. They can write down your principal and move on! I am not trying to scare you with these details. There could still be bonds that are worth your attention but only if you know that these are unsuitable for capital preservation and that the risks are high. They are most definitely not a substitute for FDs.
This is not to dissuade you from any of the above products. I would like you to understand that some of them can carry price volatility (from interest rate moves) and can cause capital losses, while some carry risks you did not know existed.
If you didn’t know this, you may be looking at the wrong options, and if you were simply looking for substitutes for deposits. Should you, therefore, stick to low-interest deposits? You should, if you are only looking for products similar to FDs.
You should go for the above options or similar ones only if you understand market risks. That is, the price of these instruments can swing to market movement (like equity) and even cause losses temporarily or for extended periods.
You need to understand if your timing is right whether the residual maturity is low or high, to assess the risk. Otherwise, it is better to wait it out with deposits. Interest rates are unlikely to remain low for years together.
A year or two will likely see rates move north. Bear the pain for a while and do not also yield to high rates offered aggressively by new-age banks. While you have the comfort that banks aren’t allowed to fail in India, a merger or restructuring or even bank insurance is not a quick solution to getting back your money. In these times, discretion is the better part of valour.
(The author is co-founder, Primeinvestor.in)