Interest rate fall- Think beyond bank fixed deposits…

Though lending rate decline is good news for home loan buyers, decline in FD rates are making investors worry. With interest rates for deposits falling to 6-7% levels retail investors are feeling the pinch. So how to deal with a falling interest rate scenario and are there alternatives is what investors are thinking now. Mutual funds, NCDs, tax free bonds, small savings schemes and even FDs are fixed income avenues available to investors which need to be review whenever such scenario occurs.

Invest a part in equities 

Investors are advised to follow an asset allocation approach, wherein a portion of the investable surplus is invested in equities (direct shares or through mutual funds). Equities are for long term horizon and cannot be exited based on certain events. How much exposure should be taken in equity is factor dependent on age, time horizon of goals and investors. For example an aggressive investor exposure in equities with more than 10 years can go up to 60-70% while a conservative can stick to 25-30% in equities. In the long run historically it has been observed that equities can give about 14-15% returns on an average.

Restructure your fixed income portfolio
While a decline in interest rates is beneficial to home loan borrowers, it also brings down returns from bank fixed deposits. As bank FDs lose sheen, investors are forced to look at alternatives. Here are few options one can delve in:
Debt mutual funds- Not many investors are keen to invest in debt mutual funds. But it throws up opportunities in rising or falling interest rates scenarios. Debt mutual funds have various categories of schemes in which money can be invested for a time frame ranging from one day to more than five years. In a declining interest rate scenario debt mutual funds (dynamic bond funds/ Income Funds – which are holding longer term maturity papers) can provide excellent tax free returns. Debt Mutual Funds would have across various holding periods provided 9-11% returns over the last couple of years due to sharp fall in interest rates. Over the next year one may expect 8-9% returns & if held for more than 3 years returns would be largely tax free. For investment horizons below 1 year one may look at liquid/ultra short term funds, 1-3 years- Dynamic Bond Fund/Short Term Bond Funds and for over 3 years- Income Funds.
NCDs/Corporate FDs/Bonds- Non-convertible debentures/ Corporate FDs were in focus when interest rates were at peak and good companies came out with NCDs at rates higher than 10%. With rates falling now one cannot expect that kind of returns. A few companies are about to launch their NCDs. It is expected that they may come out with 8-9% interest rate. These interest rates are better than traditional deposits. Investors looking for steady income can find these attractive. However NCDs & Corporate FDs have their own risk which needs to be factored in your decision making. Ideally one should not go beyond 10-15% of their fixed income portfolio.
Small savings schemes- Despite their interest rates being reviewed regularly & declining, they are significantly higher than bank FDs. PPF offers an interest rate of 8%. Sukanya Samridhi Yojna Scheme (SSYS- for female girl child) offers an interest rate of 8.5%. PPF and SSYS investments are also tax exempted u/s 80C. Post tax return above 8% in the current scenario is good for fixed income portfolio. Senior Citizens Savings Scheme- SCSS also offers an interest rate of 8.5%, though taxable it is still attractive especially for lower tax slab retirees as one can invest upto a maximum of Rs.15 lakhs. These small savings scheme are a good bet considering the locking of interest rate for the long term or its non taxability.
Thus to sum up if debt/equity mutual funds are not in your portfolio till now have a relook. Do your homework and ensure that you at least beat inflation in your fixed income portfolio.

Sabyasachi Paul has been associated with equity research and advisory on equity markets in India for over 9 years & currently heads the equity research desk of Eastern Financiers Ltd, Kolkata.He also manages a portfolio on the online platform Kristal. Find link to the strategy named ‘The Tortoise’ 

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