Uncertain times for debt investors

Investors should look at short-term or floating rate schemes for market-based returns.

On Friday, the Reserve Bank of India (RBI) increased the key policy rates like the repo and reverse repo by 25 basis points.

The repo, the rate at which banks borrow from RBI, will now be at 5 per cent. Similarly, the reverse repo, the rate at which banks park their surplus cash with the central bank, is at 3.5 per cent after this hike.For debt investors, there is good news.

However, it is too soon to take a long term call. Fixed deposit rates, which are already inching upwards, are likely to inch upwards in the next quarter.

However, some of the other debt instruments can be adversely impacted. Debt instruments that are traded have a negative correlation with the interest rates. When interest rates rise, existing papers become cheap as investors expect issuance of fresh instruments offering better rates. The converse is true as well.

But let’s first look at how the debt market functions. Debt market refers to the financial market where investors buy and sell debt securities. These securities are primarily bonds, debentures and government securities. There are also options of investing in papers issued by private sector companies.

For investors in the high tax bracket, these instruments are more tax efficient that bank fixed deposits (FDs).

Investors use mutual fund route to invest in these securities. These papers have a high face value (Rs 10 lakh and above) and are sold in lots, say 10,100 or more. This means minimum investment, here, can be as high as Rs 1 crore. However, through mutual funds, one can invest in these papers, for as little as Rs 5,000.

At times government companies, such as Nabard and rural electrification companies launch schemes for small investors. These investors can put their money directly into such issues.The two broad segments in the debt market are government securities, or G-Secs and bond market.

G-Sec: In this market, investors trade securities that a state or central government issues. The government issues papers when it needs money. These instruments have a sovereign guarantee and, hence, they are the safe instruments. However, the safety also means lower interest rates than the corporate papers and bank FDs. In mutual funds, investors have the option to invest solely in such papers through G-Sec schemes.

Bonds: It consists of financial institutional bonds, corporate bonds and debentures and public sector companies’ papers. Institutions issue these bonds to meet their financial requirements at a fixed cost. Mutual funds offer exposure to these instruments through different categories depending on the tenure. These include liquid schemes (short-term), medium- and long-term schemes.

When interest rates are rising, financial planners suggest to put money in liquid, liquid plus or floating rate schemes. These schemes invest in short-term government papers and offer returns similar to current market trend. There are fixed maturity plans (FMPs) that have tax advantages if you stay invested for one year or more. Before investing in any company’s papers, look at the profile, its rating, market perception, solvency, etc. For mutual fund investors, this information is available at their websites.

The author works with ApnaPaisa.com