As debt funds lose sheen, time for a fresh look at direct bond investing
With the turn of the financial year, bonds could soon emerge as the preferred mode of investing for those seeking regular income with safety of capital. Interest rates could be peaking and investors may want to lock in returns for the long term. Other than the attractive yields, a big change in taxation should make investors consider owning bonds directly in their portfolios. Gains on debt mutual fund units bought on or after April 1, 2023 will be taxed at their slab rate irrespective of the duration the units are held. Earlier, gains on units held for more than three years were taxed at LTCG rates (20 percent post-indexation or 10 percent without indexation). Now capital gains on debt funds as well as interest on bonds and fixed deposits both get taxed at the slab rate and hence are at par on taxation.
The rationale
The rationale behind the move appears to be that since indexation is not available for bonds and fixed deposits, why allow debt funds which ultimately invest in bonds enjoy this benefit? With this step, Finance Minister Nirmala Sitharaman has taken a firm step towards creation of a level-playing field in the debt universe. This will ensure the development of the corporate bond market amongst retail investors who are more likely to assess the direct route to bonds investing before writing the cheque.
The bond yields are higher in the case of corporate bonds, but these would come with a higher credit risk. Good quality names with strong credit ratings or curated offerings can be an attractive option for investors. As many investors look to directly invest in good quality bonds, the demand for these bonds along with government securities, should go up. Investors may choose to purchase these bonds through online bond platforms that diligence the securities before offering them.
Need for diversified portfolio
Investors may want to build diversified portfolios of bonds with credit ratings starting from AAA to BBB, if their risk-taking-ability supports. Investors can also ladder their portfolios by buying bonds maturing at different times – say 1, 3 and 5 years. This helps reduce the reinvestment risk.
Ideal holding period
Investors who are comfortable with holding bonds till maturity are more likely to do well in direct bond investing as getting an exit before maturity can be a challenge due to low liquidity. Debt funds can be considered by investors who are keen on assured interim liquidity and deferring the tax liability. Investors pay taxes in the debt funds only when they redeem their units. The time may be ripe to invest in bonds and own them directly in one’s name.
Team AltiFi.