May 15, 2020
Successful investing is about managing risk, not avoiding it. – Benjamin Graham
As we start this financial year, we already know we are in for a bumpy ride. During this phase of heightened uncertainty, RBI’s monetary policy will be an important tool to get our economy out stronger and stable.
Recently, RBI announced a mammoth stimulus of 3.7L Cr in its effort to tackle economic challenges arising due to this Covid-19 pandemic. As with all key policy actions, their ripple will lead to multiple second and third level effects. One such effect is already starting to show in the Fixed Income / Debt markets. Fixed Income markets have historically seen rate cuts during periods of growth slowdown. An analysis of previous crisis shows that rate cuts of an upto 5% were required. This in India’s current context means close to 0% repo!
Even if we cannot imagine the future FD rate in this context, think of it this way – post recent RBI policy banks get access to 1L cr at below 4.5% rate for 1-3Y. In a situation where banks have cheaper capital access and rates are expected to remain low in the near to medium term, can be simply extrapolated to FD rates. In this context, Banks have cut Fixed deposit interest rates. Simultaneously, the Government has also announced sharp cuts to their savings schemes (incl. PPF, SCSS, NSC etc.)
With even 3Y Bank FD now yielding 5.7-6%, the returns of investors have come down to ~4.0% on post tax basis (assuming 30% tax slab). This is at a time when our equities are already down and need 1-2 years to recover. Accordingly, it is a good time to consider diversifying our best fixed income investments and add allocation to Debt Mutual Funds.
Why Debt MFs?
We look at a comparison basis key parameters that one considers while doing an FD.
Returns
- As discussed with FDs, post tax returns are now ~4%.
- There is also a cash flow impact due to quarterly TDS and year end tax outflows
- On the other hand, Mutual funds are taxed only on redemption and at a lower rate with indexation benefit if held over 3 yrs (effective tax rate comes to ~11%)To put this in context, a FD of ₹10L at the end of 3Y will give interest of ₹1.3L on maturity (post tax), while a Debt fund of similar credit quality will give gains of ₹1.7L
Safety
- Bank FDs have a deposit insurance of upto ₹5L. Here, the important part to remember is this ₹5L is cumulative limit for all deposits of an individual with a bank.
- Mutual funds approach risk management through diversification and analysing each business groups.
- Each scheme can have 10-100 different issuers with SEBI defined limits to sector and issuer exposure.
- We add a layer of our analysis, to pick the safer funds and have a track record of seeing no loss due to default even during 2018-19 NBFC crisis.
Liquidity
- Bank FDs provide option to break the deposit with immediate liquidity subject to premature withdrawal penalty.
- Debt Mutual funds credit the proceeds of redemption in 1-2 working days
- Our recommended list of funds do not have any exit charges irrespective of holdings period
Market inconsistencies can be tricky to tap and risk evaluation matrix is what define who will end up better off at the end. Each time a crisis strikes, it leads to new learning and smart investor tend to lead the way by making shrewd choices.
Now is the time to be smart and act swiftly.
