LIQUID & LIQUID PLUS FUNDS
Traditionally, these funds are seen as a good parking space for your money. But things have changed now. Inflation for the month of March 2011 is substantially above the expectation of Reserve Bank of India and yields are expected to move up in near term. Liquidity may not improve in the immediate future. That makes a strong case for liquid and liquid-plus funds. These funds invest in short-term instruments with maturity of a few days to less than one year. They are better placed to catch the rising short-term interest rates. Fund managers have locked in most of the money invested in these funds at attractive yields towards end of March. That should offer good returns over the next couple of months.
THe category, stand at 0.7% whereas liquid plus funds returned 0.85% as on April 13, 2011. The dividends distributed by liquid-plus funds are taxed at 13.52% which if compared to the 30.6% tax on interest on fixed deposits makes the case strong for these funds in case you are exploring investment options for less than six months. Dividend option is a better way to invest in this low-risk investment avenue.
SHORT-TERM FUNDS
If you are an investor with a time frame of more than six months, liquid-plus funds may not offer you the best deal. If liquidity were to improve and inflation were to cool down towards the end of the second quarter of the calendar year (CY) 2011, short term interest rates may fall, and these very factors will then hamper the performance of liquid plus and liquid funds. Given the good accruals, fixed-income investors can consider short-term bond funds if they are looking for an investment for at least six months. Here, returns come in the form of accruals or the yield to maturity of the fund minus its expense ratio. Short-term bond funds got the opportunity to invest in fixed-income instruments offering double-digit yields in March 2011 and fund managers happily locked in high yields. Short-term funds with portfolios with one to two year duration should deliver well over the next one year. One can expect 8.5-9% returns from these funds.
FIXED MATURITY PLANS
Though there are not many FMPs available now, you may see one coming your way in the near future as short-term interest rates move up further. Depending upon your need, you may invest in an FMP from a good fund house. But a word of caution, invest only that amount of money that you will not need till the scheme maturity, as it may be difficult to sell the units on the stock exchange if you need the money before the scheme matures.
LONG-TERM FUNDS
If you are willing to take risk and are keen on investing for 18-24 months, long-term debt funds may offer promising returns. Gilt funds look good with a two year time frame if you could enter at a time when the benchmark 10-year bond yield quotes in the range of 8.4 to 8.5. As we are nearing the peak of inflation and interest rates, gilt funds offer the investors an opportunity to ride the rally arising out of falling long term interest rates in the future. The returns earned by the investors comprise interest earned and capital appreciation. As interest rates fall, bond prices move upward resulting in capital appreciation.
As gilt funds invest in bonds and securities issued by government, there is minimal default risk in gilt funds. But here is a word of caution. If interest rates move up further in short term, the investor may see marked-to- market losses in his portfolio. So prepare for some bumps in the near future. If you cannot invest your money for at least 18 months, stay away from these funds.
If your investment horizon is of two years, you can look at income funds for good risk-adjusted returns. These funds primarily invest in bonds issued by corporate entities across sectors and with different credit quality. As investors are exposed to credit risk, the coupons on offer are higher than no-risk government bonds of similar tenure. That culminates into higher returns, albeit at a slightly higher risk compared to a gilt fund.
LISTED INSTRUMENTS
Many fixed-income instruments, such as those issued by L&T Infrastructure Finance, Shriram Transport Finance and State Bank of India are listed on the National Stock Exchange (NSE). If you have a demat account, you may consider investing in these instruments. You stand to earn interest at regular intervals and you may choose to trade in bonds if the prices move up. There are some instruments with call option – a right with the issuer to withdraw the bond on a stipulated date paying the face value of the bond to the holder of the bond. If you buy a bond above the face value and the issuer calls back the bonds, you may see a capital loss here. One more risk the investors are exposed to is the risk of inadequate trading volumes on the stock exchange, making the pre-maturity exit difficult.
FIXED DEPOSITS
Fixed-income investors, who prefer capital preservation and safety, should look at medium term fixed deposits to lock in the current high rates, though the post-tax returns are not as attractive as an FMP. You can earn 9% interest – before tax – if you sign up for a fixed deposit for at least one year. However, there are not many options among company fixed deposits. Since company fixed deposit rates do not compensate for the higher risk investors are exposed to, bank fixed deposits are a better investment option.
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