Where can you invest if interest rates on bank FDs fall?   Apr 10, 2013

In turbulent time such as at present, many investors have thus far evinced interest in a safer investment avenue which is Fixed Deposits (FDs) with a bank. And thanks to the high interest rate regime and moderation in WPI inflation that the real rate of returns obtained on most of them has been positive. But have you as investors kept your options open if interest rates fall further? While the Reserve Bank of India (RBI) has signalled that further monetary easing remains quite limited and believes that Government has to play a key role in reinvigorating growth; recently a few banks (such as Punjab National Bank, Bank of Baroda and Oriental Bank of Commerce) have already slashed interest rates on fixed deposits, as the street expects RBI may cut policy rates further by 25 basis points (bps) in its annual monetary policy 2013-14 (scheduled on May 03, 2013).

Hence in such a scenario, where other banks could follow suit have you as investors, thought of an investment strategy or other investment avenues, which could yield you better and tax efficient rate of return.

Well, here are some options which can help you clock a decent rate of return by taking high risk:

  • Dynamic Bond funds: Ascertaining that the interest rate scenario in the country yet appears uncertain in the backdrop of host of global headwinds and domestic macroeconomic data, dynamic bond funds which are actively managed and invest in fixed income instruments (such corporate bonds, NCDs, Certificate of Deposits (CDs), Commercial Papers (CPs), Government bonds) across maturities and have the flexibility to shift their portfolio maturity profile, could be considered provided you are willing to take high risk as against your investments in bank FDs. So far in the last 1 year, dynamic bond funds have delivered on an average 10% rate of return.

    While selecting a dynamic bond fund for your portfolio, select scheme(s) from a fund house which have at least 3 year of track record, and even the scheme per se which has been in existence for at least 3 years. Moreover apart from evaluating them on the basis of just return, you need to delve deep into the qualitative aspects such as portfolio characteristics (which includes rating profile of the debt papers held, average maturity, portfolio concentration), performance parameters (which includes risk-return ratios, performance in various interest rate cycles), expense ratio, fund manager experience and number of schemes managed by him; amongst host of other intricate details.

  • Fixed Deposits offered by companies: If you are not comfortable in investing in dynamic bond funds (which are actively managed), the other investment option you may consider is FDs offered by companies. But rather than only getting lured by the high rate of interest offered by some of them, it is imperative to assess the risk profile assigned to them by respective rating agencies.

    Moreover it is important to understand the nature of business the company is involved in and thereafter the business model. One should also assess the amount of debt which the company is already carrying on its balance sheet and judge important ratios such as interest coverage ratio and capital adequacy ratio.

We are of the view that the ascending trend in retail inflation with it yet continuing to be in double-digit at 10.91% for the month of February 2013 (led by sustained price pressures from food items, especially cereals and proteins), is infusing concerns. The divergence between WPI Inflation and retail inflation has continued to widen and now since prices of diesel (which is an essential transport fuel) and freight being increased inflationary pressures seem evident. Thus under this backdrop where there are chances that real rate of interest could contract, the aforementioned investment avenues could help you clock better real rate of return provided you are willing to take high risk as against your investments in bank FDs.

If you want to invest for the short-term time horizon of say less than 3 months, you would be better-off investing in liquid funds for the next 1 month, or liquid plus funds (also known as ultra-short-term funds) for next 3 to 6 months horizon.

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Jun 22, 2013

I was drawn by the honesty of what you write