Bet on bond funds, company deposits

With interest rates likely to fall, rejig debt portfolio in tranches

With the call for a rate cut getting louder after the Union Budget, retail investors would be worried about their debt portfolios, and for good reason. Returns from debt, at 9-10 per cent in the past year, have given them some solace from rising inflation.

But, the strategy needs to be different, going forward. Given that a fall in interest rates leads to increase in bond prices, Nilesh Sathe, director and chief executive officer of LIC Nomura Mutual Fund says this is the time for investors to move to bond funds. And, add some corporate fixed deposits, too.

According to mutual fund rating agency, Value Research, bond funds (medium- to long-term or three to five years) have returned a little over 10 per cent in the past year ended March 1, 2013, while corporate deposits from financial services companies are giving anywhere between 8.75 to 10 per cent for a year and manufacturing companies are giving 9-11 per cent (for one year).

But don't go just by returns. If a company deposit scheme is paying high returns, it is most likely rated low and vice versa. So, do not blindly follow the returns on offer. Sample this, while a Dewan Housing pays 10.25 per cent for a one-year deposit, LIC Housing Finance will pay 8.75 per cent. Similarly, United Spirits is offering 11 per cent for a year, while Mahindra & Mahindra is paying 8.50 per cent for the same period (source: Bluechip India).

Says financial planner Anirudha Hatwalne, "If an individual has an investment horizon of two to three years, getting locked in to higher rates before rates fall would help. If you can stomach higher risk, add corporate deposits but only of high (AAA) rating."

Remember, corporate deposits are unsecured and in case of a default, investors can find it difficult to recover their money. Liquidity is another issue. Investors might not be allowed to break the deposit for up to six months. And, if one is allowed, he/she is likely to be penalised by one-two per cent of the applicable interest rate for the period invested.

Explains Raghvendra Nath, managing director of Ladderup Wealth Management, that investors with a horizon of three years or more can allocate up to 70 per cent of their debt portfolio to long-term instruments like tax-free bonds and the remaining in long-term debt funds. Those with two to three years in hand can allocate up to 70 per cent of the debt portfolio to bond funds and the rest for corporate fixed deposits.

If you cannot take risk with your debt portfolio or if you are a conservative investor, sticking to bonds and bank deposits is suggested. "If an investor has time only for say six months or one year, he/she will take a lot of risk with long-term funds. Such investors should opt for short-term debt funds (annual returns fall in the range of 9-9.50 per cent) and bank deposits," says Nath.

But do not shift your money in one go. Move in tranches as the central bank will cut rates only over a period of time.