Earlier this month when we gave our first call on G-Secs and SDLs (available for Growth subscribers), some of you had the – very valid – question on how to use these debt investment options in your portfolio. At various points too, we have received similar questions on options for the present rate cycle or how to use certain fixed income options. These questions assume importance in the present changing rate scenario and we thought we should address those questions. Let me list down some of the common questions:
- Should you substitute some of your long-term mutual fund investments with G-Secs and SDLs?
- Should you hold or exit your gilt funds in the present rising rate scenario?
- Can your PPF or other traditional fixed income products can be the ‘debt portion’ of your long-term portfolio?
- Even short-term debt funds returns are low. Does holding them make sense?
- Where should you look for better returns now given the low returns in debt funds?
We’ll now try to answer these questions in the article. You can directly go to the respective section by clicking the links for each of the above.
#1 How to use G-Secs and SDLs
When we started coverage of G-Secs and SDLs recently, the idea was to provide an income stream for those looking for safety along with reasonable returns. When it comes to this combination, two widely available options are the RBI Floating Rate Bond and PPF. Options such as Vaya Vandana Yojana and Senior Citizens’ Savings Schemes are restricted to a one segment of the age group and that too with limit (Rs 15 lakh each) on how much you can invest. Hence, in a rising rate scenario, G-Secs and SDLs offer this great and sought-after combination of ‘safety’ and ‘good returns’ that you can lock into for the long-term.
In other words, our calls, at this juncture, are meant to be ‘buy and hold’ calls to generate steady returns from instruments backed by the government. Our calls are not meant for trading or selling in between. Yes, you can do that too. But our endeavor at this point is to lock into the higher yields (as yields are moving up) in these instruments.
Now, with our intention clear, here is how you can use G-Secs and SDLs. Keep in mind that these instruments have ONLY half-yearly interest payout options.
- One, you can use G-Secs and SDLs for generating regular income that will likely be better than your annuity plans and with low to nil risk. They are ideal instruments to set up a stable and predictable income stream.
- Two, you can use such interest income to do your SIP (Yes, you can use the interest income to invest in equity) provided you are not in a high tax bracket as you will be paying tax on the interest at your slab rate. Those in the lower tax bracket will be less hit.
A very important point to note here is that unless you have ‘capital appreciation’ opportunities (by selling them in between) these cannot be used to grow your wealth as there is no cumulative option. That essentially means they cannot be readymade substitutes for your gilt or long-term mutual funds, which can grow wealth as returns compound over time and are more tax-friendly.
Will this mean that gilt funds will always deliver higher than ‘buy and hold’ g-sec because there is capital appreciation in the former? Not necessarily. Much depends on the yield at which you bought the G-Sec or an SDL. Just to give you an example: Had you invested in gilt funds in February 2012, your 10-year returns would have been 8.04% on an average pre-tax (for all gilt funds with 10-year record).
However, the returns (total return index – which includes the interest added back) on the CCIL 5–10-year G-Sec index was 8.6% over a 10-year period. This was because in 2012, when you locked into these G-Secs they were at a high yield (8.3-8.4%) and low price. So technically, your returns for the price you entered was superior. Here, just the timing helped.
This may not happen at all times. The bottom line is that mutual funds help accumulate your wealth and also provide capital gains indexation benefits and therefore superior returns net of tax over the long term. Therefore, substituting funds with G-secs may not achieve the purpose. It is ideal to keep G-Secs and SDLs as separate investment options, as part of your 100% safe fixed income options.
If you decide to buy G-Secs or SDLs in your debt investment options, make sure you buy them in tranches even when we give our calls. As rates move up, you may have opportunities to lock into higher yields as well. So, when we give a series of calls (not possible for us to time the best one at peak rate), you should not invest your surplus in one go.
#2 Should you exit your long-term/gilt funds now?
Whenever we give our debt outlook, or strategies for the present rate scenario, or recommend a short-term debt fund, we get the question on whether you should exit your gilt or long-term debt fund. The answer is always a NO, provided your holding time frame is what we recommended for that portfolio or for that fund. For example, a constant maturity fund is part of our over 7-year portfolio. And over 7-year periods, gilt funds do not have a history of generating negative returns.
If you take the 2012-22 period, the average rolling 7-year return for gilt funds was 8.15% and the worst was an average 5.1%. Now the average 7-year return for the ultra-short-term category over the same period was 7.5%. So, holding a longer duration fund over its time frame does pay in the end – if you will put up with the near-term volatility in it.
The graphs below give the movement of a gilt fund NAV over 10 years and over 1 year. You will see high volatility over a 1-year period but such bumps are hardly visible in the longer-term return graph. This is the exact case with all your long-term debt funds as well.
When rates start moving up, the prices of debt instruments fall to adjust to higher yields. So, you will see negative or poor returns in your longer duration/G-Sec funds. But once fund managers add more higher yield instruments the ‘accrual’ (interest income) starts compensating and your returns become less volatile and improve. The only catch here is when the rate upcycle is very slow and very prolonged, then you may see a higher period of volatility. Even so, it is unlikely to last over your entire holding period for such long-term funds.
When we give short-duration fund calls, they are about where to invest fresh money for the short-to-medium term and not about ‘replacing’ your existing funds. If we intended that, we would state it explicitly. Bottomline - avoid troubling your time-frame based portfolio investments because near-term returns look poor or because we highlight other funds. Adding shorter duration funds to existing portfolios will help combat volatility and to capitalize on available opportunities.
The same is true of categories like corporate bond funds where the minimum holding time frame is 3 years and above.
#3 PPF as part of your debt portfolio
PPF is also a government fixed income option – with interest rate that can change. You don’t lock into a particular rate. No doubt, it can be part of your fixed income portfolio as PPF has seldom delivered lower than FD rates and is tax-efficient to boot. (See the PPF Interest rate history here)
The only limitation when you use it with equity mutual fund portfolio (for asset allocation purpose) is that you will not be able to rebalance effectively – especially when you want to switch from debt to equity when the market falls or park some money in debt when equity swells. There, in addition to PPF if you have some liquid instruments (i.e., any open-ended debt fund) that can help rebalance your portfolio, it will provide more flexibility to keep your portfolio in sync with your original allocation.
#4 Where to go for better returns for shorter duration
While the yields of shorter duration funds have started moving up, it is true that it may not be sufficient for those looking for some income out of these funds, especially for doing systematic withdrawal. In such cases, we had, in our strategy call in November 2021, suggested options outside of mutual funds too, to look for better returns. You could also check Prime deposits and besides looking at the safety of some of the higher interest-paying banks in our FD comparison tool and pick based on ‘Prime Confidence’ level.
But here again, if you don’t really have an income requirement, there is no harm holding to your short-term funds as yield improvements can adjust their returns with some lag. For example, when a series of rate hikes happened between March 2010 and March 2011, ultra-short-term debt funds took a bit of time but then started seeing steep climb in returns in a year’s time. Hence, exiting may only result in opportunity loss.
#5 Where to look for better returns?
The point above explained debt investment options outside of mutual funds that you could use for higher returns. While these are more short-term in maturity periods, this short lock in would help you again catch higher yields when rates move up further down the line.
Meanwhile, if you have higher risk appetite, then primary market bonds with above average credit rating and medium-term maturity (3-5 years maximum) may be one option. For those with a large investment corpus, private placements of bonds with higher yields but without too-high risks can be another option. At PrimeInvestor, we will also be selectively covering these options (for Growth subscribers) in a few months from now.
To put it very simply – when you invest in a debt fund with the right timeframe, stick to it. This holds especially true for those with long-term debt portfolios, where it is best not to disturb your portfolio and allow the rate cycle to play out. Use our newer product recommendations for fresh deployment or to diversify away from debt funds.
