It is time to take advantage of attractive interest rates

It is time to take advantage of attractive interest ratesWe all know that interest rates have been rising for over a year now. And while investors have grappled with the fallout like rising loan rates, it’s also a fact that investment options such as bank fixed deposits have turned attractive. But as financial advisors will tell you, there are more attractive fixed income investment avenues than deposits alone.

One such avenue that’s turned attractive is short-term income funds. “Short-term income funds are looking good with interest rates increasing every quarter and as these funds have low maturity and low duration portfolios currently,” says Mukesh Dedhia, director, Ghalla & Bhansali Securities. Short-term income funds invest in shorter maturity securities such as commercial papers and one-year certificates of deposits.

Dedhia points out that these funds currently have an average yield to maturity (or the return if the debt paper is held to maturity) of over 10 per cent. Assuming an expense ratio of about 1 per cent, investors can expect a return of around 9 per cent over one year, explains Dedhia. “This looks very attractive,” he says. There’s a capital gains tax of 10 per cent (20 per cent with indexation) on the growth option, which is better suited for long-term investments.

Meanwhile, Suresh Sadagopan, principal financial planner, Ladder 7 Financial Advisories, feels that investors should “lock in on the attractive interest rates” already prevailing in the market by investing in fixed maturity plans (FMP). FMPs are close-ended debt funds that hold their investments to maturity, thus eliminating the interest rate risk.

Remember, the Reserve Bank of India (RBI) has been consistently raising interest rates since March 2010. Rates have risen because of several factors like inflation, tight liquidity, and economic growth. True, in recent weeks, liquidity pressures have eased up and so yields on one-year papers have come off slightly. But other concerns remain.

Says Dedhia: “Early signals could suggest that interest rates have peaked out but one is not sure. If inflation goes down and if economic growth is hampered further, interest rates would go down slowly and steadily But food inflation is not coming down yet. It’s a wait and watch scenario still.”

Sadagopan too says: “In general, one expects the tightening to continue for another three to six months.” That’s why he feels investors could lock into FMPs now. Given the prevailing rates, one-year FMPs should give pre-tax returns of 9.5 per cent-9.6 per cent, or post-tax returns of 8.5 per cent to 8.7 per cent.

In comparison, one-year bank fixed deposits are currently offering 10 per cent to 10.25 per cent or a post-tax return of 7 per cent to 7.2 per cent at the highest tax slab. “A one percentage point arbitrage on the FMP is still attractive,” says Sadagopan.

For investors with a horizon of three to six months, Sadagopan suggests money manager or ultra short-term income funds. “With a dividend distribution tax of 13.5 per cent, these schemes give better post-tax returns than FDs,” he says. They’re also a better way of “maintaining liquidity” than savings accounts. According to valueresearchonline.com, the ultra short-term debt fund category gave a return of 7.53 per cent for the year ended July 15, 2011.