2 safe options to earn 7.4%

India’s market interest rates have been rising very swiftly after the recent mid-cycle rate hike by the RBI.  In our earlier analysis we had highlighted that bonds issued by the Central and State governments should now be your first choice as and when primary auctions crop up, as they offer the best combination of low risks with high yields currently. 

In line with that call, we would now like to alert you to 2 more Central government securities (G-secs) that are currently being auctioned on the RBI Retail Direct portal. You might want to check if your brokerage has the option to buy these. 

Here are some basics to know if this is the first time you are venturing into G-Secs.

• Know all about G-Secs in this RBI Retail Direct FAQ
• Know everything about opening an account with RBI Retail Direct in this RBI link

A Caveat

Before we move to the recommendations, do note that buying g-secs directly has a couple of disadvantages, compared to buying gilts through the mutual fund route. When you buy g-secs directly, the interest payouts are not accumulated on the bond and paid out to you regularly. These interest receipts are taxed at your income tax slab rate, reducing your post-tax yield. 

Mutual funds that invest in gilts in contrast, accumulate interest in their Growth options and also give you indexation benefits on capital gains after a 3-year holding period. Liquidity on g-secs before maturity can also be patchy, compared to MFs that give you anytime exit. To address these issues, we plan to come up with MF recommendations to play this yield opportunities on Friday. So if you have limited debt money to deploy and don’t need income out of this investment, you may want to skip this recommendation in favour of the MF calls. 

On the other hand, if you don’t mind holding to maturity and would like to avoid the risks that fund managers may introduce into a debt fund, then you can consider participating in the two Central g-secs being auctioned below.  

In line with the above, we have identified 2 opportunities in the present auction by the Central government. One is a 7-year G-Sec with maturity in 2029 and indicative yield of 7.48% and the other is a 10-year G-Sec maturing in 2032 with indicative yield of 7.46%.The latter being a 10-year g-sec is likely to be more liquid than other instruments.

You need to know the following:

• There is a coupon rate (the interest you will earn) mentioned when you bid, along with an indicative yield that is mentioned. The actual yield you will get on allotment will be the effective interest rate for the price at which the g-sec is allotted to you. This is likely to be close to the indicative yield. Yield is nothing but the interest income dividend by the purchase price.
• The yield will be known only after the auction closes. Therefore, at the time of applying, you may be sometimes asked to pay a little more than the amount you bid for, as a mark-up. The same will be refunded based on what the final yield is. 
• Interest payments on these instruments are credited half-yearly. There is NO cumulative option. There is no TDS deducted. However, interest is fully taxable at your slab rate. 
• In our calls, we will mention the bidding opening and closing dates, and the last dates for UPI and net banking transfers. Please note that the net banking option closes early. You need to invest quickly before the window closes. You can use UPI as well, which closes later, but note that the UPI limit is Rs 2 lakh only. Make sure the bank account linked to UPI is the same as the bank details given when you opened the RBI account. 
• The bonds you buy through RBI Retail Direct will NOT get into your demat account. It will be credited and held in Retail Direct Gilt (RDG) account. You can sell them through the RBI Retail Direct Secondary market account, for which you will have access when you open an RBI Direct Gilt account. 
• Very importantly, we have nothing to do with the operational aspects of these bond issues. Kindly DO NOT WRITE TO US with queries on your allotment or bidding status. Our job would only be to alert you on timely opportunities. Write to [email protected] for any queries or call their customer support. We have tried this over the past month and have found them to be responsive. 

Please read this detailed FAQ from RBI if you wish to know about bond issue price and yields. You can also read this explainer on the RBI Retail Direct platform that we wrote earlier. In general, the window for these auctions is very short. You have to keep tabs of our mail alerts on these recommendations and act fast.

Suitability of the bonds

• The 2029 maturing G-Sec is ideal for those who have regular income needs and can afford to lock in their capital for good safety with high returns. Compared to 5-year bank deposits which today offer 5.5-6% or Post office options like the 5 year NSC that offers 6.8%, this bond offers a much higher yield of close to 7.48% with sovereign safety. The only caveat is your willingness to hold it for 7 years. It is ideal for those looking for income options and in a lower tax bracket. Given the bond’s odd maturity (7 years), the liquidity via secondary markets may be lower than for 5- or 10-year bonds. 

• The 2032 maturing G-Sec is suitable as a long-term buy-and-hold option given the attractive yields. It is ideal for those who want to set up a steady income stream. It can also be used by those who want to preserve capital even if they don’t need the interest income. But you need to make sure the interest is redeployed into building wealth. 10 year g-secs score over other maturities because they tend to be more actively traded by institutions. 

• These bonds are primarily for buy-and-hold purposes. The issue size of both these bonds are significant, but there’s no guarantee of liquidity in case they need to be sold in the secondary market. 

• Though yields on long term bonds are already at attractive levels, nothing stops them from moving up even further. If yields rise further over the next one or two years, as we expect them to, your holdings in these g-secs will suffer mark-to-market losses. But the losses will be made up over the long run. You need not worry about such losses if you are holding the bond till maturity, as you are sure to get back principal. A longer maturity bond’s price will be more sensitive to rate movements. For example, the 10-year G-Sec can have higher mark-to-market losses than the 7-year G-Sec when rates move up. The reverse is also true when rates fall. So, unless you are a buy and hold investor, you should know when to exit if you plan to sell midway.

Please note that like we stated in our earlier article, you will need to spread investments and not deploy your entire surplus now. It is difficult to precisely time the rate hike. We will be giving calls at higher rates as well. Therefore, you can reserve some amount for later. You can also build a barbell strategy by mixing bonds across duration, using mutual funds for shorter periods. You can check our Prime Bonds page for active and closed bond calls.