Don’t lose money when interest rates drop

There are some pockets within debt mutual funds which offer hope for investors

The Reserve Bank of India (RBI) has been reducing interest rates to fight the economic slowdown. Accordingly, bank deposit rates are coming down. Rates on other instruments are also following suit so that the entire interest rate structure falls in line. Falling interest rates is a global phenomenon as every country is struggling with growth. While low rates are good for those who want to avail loans, it is not so good for savers. We discuss here some pockets within debt mutual funds, which would be interesting in the current scenario.

Let us see what options you have for fixed income / debt investments. For bank deposits, the rate on a State Bank of India deposit of 5-10 years maturity is 5.4%. The rate on Kisan Vikas Patra is 6.9%, National Savings Certificate, 6.8% and Monthly Income Account, 6.6%. Public Provident Fund (PPF) pays 7.1% currently, but there is an upper ceiling on investment i.e. ₹1.5 lakh per year. The 7.75% RBI Savings Bonds have been discontinued. They may be relaunched but the interest rate would be lower. Yields (annualised returns) of tax-free PSU bonds in the secondary market are only 4.6% to 4.7%. Against this backdrop, we will discuss certain debt mutual fund investment options. Portfolio credit quality is important as you do not want any default risk. We will mention only those funds that have a AAA-oriented/Government Security-oriented portfolio. In this context, it is relevant to understand the concept of debt fund portfolio maturity roll-down.

Let’s say there is a Fixed Maturity Plan (FMP) with a 3-year maturity. As per the rules, the maximum maturity of securities in the portfolio can be 3 years. After one year, the remaining maturity of bonds in the portfolio runs down to two years. After 3 years, all the bonds in the portfolio mature and you get your money back. Since the bonds are maturing, there is no volatility risk; it does not matter to you, on the date of maturity, whether bond prices in the market are going up or down.

The difference between FMPs and open-ended debt funds is that open-ended funds will always have portfolio maturity. As an example, if a Short Duration Fund has a portfolio maturity of say 3 years today, it will have a portfolio maturity of 3 years even after the passage of 3 years, or little bit here and there e.g. 2.8 years or 3.1 years. The point is, it does not behave like an FMP.

Now, the concept. There are a few open ended funds which have a strategy of portfolio maturity roll-down. It is a decision taken by the AMC to run a fund with that positioning. In an FMP, there is no redemption facility available with the AMC; in open-ended funds you can redeem i.e. liquidity is available to you.

The advantage here is, your volatility risk is progressively coming down with every passing day. There would be some volatility as of today, but you need not worry; you just have to hold on to the fund.

Since every investor would not be aware of open-ended funds run with a strategy of portfolio maturity roll-down, we have mentioned these funds briefly. Axis Dynamic Bond Fund has a portfolio comprising AAA-rated bonds. Portfolio maturity and portfolio duration is 9.5 years and 6.3 years. Similarly, L&T Triple Ace Bond Fund has a AAA-oriented portfolio. Portfolio maturity and duration is 7.7 and 5.4 years.

If you have money with a longer term objective e.g. son’s education, daughter’s marriage or want to pass on a legacy for the next generation and want to deploy it for, say, 15 years and are looking for an alternative to PPF, then you may look at Nippon India Nivesh Lakshya Fund. This fund has a portfolio comprising Government Securities only i.e. there is no credit risk. With a portfolio maturity of approximately 25 years and a modified duration of approximately 11 years, this is for the long haul.

The advantages of investing in funds with this strategy are:

1) Volatility or price movement risk is taken care of, provided you hold on for the time horizon required, which is indicated by the portfolio maturity;

2) If the interest rates come down over your holding period (i.e. bond prices move up), you would get that benefit as well in these funds. Valuation for NAV is done at market-based prices;

3) There is tax efficiency in debt mutual funds, which is not there in other taxable investments. For a holding period of more than three years in debt funds, you are eligible for indexation. By virtue of indexation, price appreciation roughly equivalent to inflation for that period is allowed as deduction for tax purposes.

If your fund gives say 7% per year for the holding period and inflation is say 4% per year, then (7% minus 4%) 3% is taxable at 20%. That is, effective tax payable is only 0.6% and your return is (7% minus 0.6%) 6.4%.

Other investments like bank deposits are taxable at your slab rate, which is 30% for most people. If you get 7% on a deposit for illustration (which is actually lower nowadays), tax payable is (30% of 7%) i.e. 2.1% and your net return is 4.9%.

(The author is founder,

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