Use the lumpsum route in debt funds

While SIP can also be used to take advantage of the falling interest rate regime, tax issues make it unattractive

There was a lot of unrest amid debt fund investors after Finance Minister Arun Jaitley increased the holding tenure for debt funds to three years for tax benefits in the last Budget. However, despite this reduction in liquidity, the fortunes of these funds are likely to change as the economy enters a lower interest rate regime, which will lead to a rise in prices of the underlying debt papers.

The question is whether one should use systematic investment plans (SIP) or the lump sum route to invest. Vidya Bala, head of mutual fund research at FundsIndia.com, feels when interest rates ease further, one-third of the debt corpus can be invested in lump  sum and the rest through SIPs.

Sujoy Das, director and head (fixed income) at Religare Mutual Fund, prefers the lump sum route because he expects volatility in the falling rate scenario to be less than when interest rates are rising. “We expect benign interest rates scenario to stay for at about three years. So, the idea should be to reduce your re-investment risk. Hence, one should pick up a fund, which has a modified duration longer than your investment horizon. If you have an investment horizon of three years, then pick up an income fund with a modified duration of nine to 10 years or you can even consider a gilt fund,” he says.

However, staying invested for at least three years will be important if investing a lump sum because of the tax consideration. If you withdraw before three years, the capital gains will be added to your income and taxed according to the bracket. On the other hand, after three years, the taxation will be 10 per cent without indexation and 20 per cent with indexation – a big benefit in years when the consumer price inflation is high.

Investors who do not have a lump sum can use the SIP route. Since the SIP route is taken to reduce volatility, use this route only for short-term or income funds, says R Sivakumar, head (fixed income) at Axis Mutual Fund. “Ultra short-term and money market funds are less volatile; so the benefit of averaging from such funds is limited. But income funds stay invested across the interest rate cycle and investors can benefit from investing through SIP,” he says. Others like Bala also recommends a dynamic bond or income accrual funds when interest rates settle down because once there are no more gains to be made by investing in longer tenure papers, these funds will reduce the average maturity of the portfolio or invest in corporate bonds.

However, remember that each SIP has to complete three years to get the tax benefit, much like SIPs in equity-linked savings schemes. This makes the process cumbersome when withdrawing.