Fixed-income instruments in India typically include company bonds, fixed deposits and government schemes. The reasons for investing in fixed income option are mentioned below.

Low risk tolerance
One of the key benefits of fixed-income instruments is low risk i.e. the relative safety of principal and a predictable rate of return (yield). If your risk tolerance level is low, fixed-income investments might suit your investment needs better. But remember that these still have risks associated and are explained later.

Need for returns in the short-term
Investment in equity shares is recommended only for that portion of your wealth for which you are unlikely to have a need in the short-term, at least five-years.
Consequently, the money that you are likely to need in the short-term (for capital or other expenses), should be invested in fixed-income instruments.

Predictable versus Uncertain Returns
Returns from fixed-income instruments are predictable i.e. they offer a fixed rate of return. In comparison, returns from shares are uncertain. If you need a certain predictable stream of income, fixed-income instruments are recommended.

Before you decide to invest in fixed-income instruments, evaluate your needs from three key perspectives - risk, returns and liquidity. Match the investment options with your financial needs.

Risk

There are two types of risks associated with investments in Fixed Income Options.

1. Interest Rate Risk
The price of the fixed income options are effected inversely by the interest rates. So, if the interest rates go up then the price of the existing bonds goes down and vice versa.  The risk becomes important if you are interested in trading in the bonds and are not likely to hold till maturity.

2. Credit Risk
Credit risk refers to the possibility that the issuer fails to pay what is owed (principal and/or interest). Evaluate the credit ratings assigned by rating agencies like Moody’s, Standard & Poor, CRISIL, ICRA and CARE to find corporate bonds/ fixed deposits that match your risk tolerance level.

Please note that it is not mandatory for non-finance companies to get a credit rating for their fixed deposit schemes. Hence, it is advisable to see if the company has a credit rating for any other debt instrument while evaluating fixed deposit schemes.
 
Also, one should understand the relation between credit rating of a company and the coupon (interest rate) which it promises. A low credit rating company would promise higher coupon than a company which has high credit rating as the risk involved in lending to low credit rated company is higher and the investor has to be compensated for the same.

So, in case of fixed income option, investor should not get allured by the returns alone and should look into the underlying risks as well.

Generally the government bonds are considered the safest as there is sovereign guarantee attached. But at the same time some countries are considered more reliable than others hence, in such a case the credit ratings of the country comes in to play. Hence, an emerging market government bonds would pay higher coupon than those issued by developed countries.

- Returns
Return calculations should consider effective yield, interest rate expectations and taxes.

1. Calculate effective yield
Calculate the post-tax effective yield for each instrument for comparison. Effective yield is the IRR (Internal Rate of Return) of the fixed-income instrument.

For e.g. for an instrument that pays 14% monthly interest, the effective annual yield works out to 14.93%. This is definitely more attractive than an instrument that pays 14% annually.

2. Consider interest rate (and inflation) expectations
Once you invest in a fixed-income instrument, your investment is committed, more often than not, for the specified period of time.

During this period, if interest rates increase, you will not benefit from this rise. Hence, your effective return from this investment will be lower than if you had the flexibility to invest at a higher interest rate.

So, if you expect interest rates to increase, invest only in short-term instruments, and vice versa.

3. Don’t forget taxes
While calculating your interest yield remember to include post-tax interest receipts. For investors in high-tax brackets, tax-free government bonds/ schemes might be more attractive.

Mutual funds present an alternative avenue to invest in fixed income instruments at zero tax liability on the income received.

- Tenure & Liquidity
The tenure of the fixed income instrument is important as the returns get influenced by the tenure. For example, the interest rate risk we discussed above, if the interest rate rises then the existing bond with longer tenure will witness higher fall in price than one with shorter tenure.

Fixed-income instruments are normally illiquid as the secondary market for these instruments is not yet developed in India. Make sure you carefully evaluate the potential liquidity, exit route and penalties of the instrument before you invest.

How to Buy?
Worldwide the secondary market for fixed income instruments is more developed than in India. There are no open exchanges in India to trade debt and in case you wish to trade in bonds then your broker will have to find buyer and sellers for you.  We discuss below the options available to the debt investors in India.

  - Company bonds/ debentures
Companies issue bonds and debentures through public issues that are open only for a limited period of time. Application forms for these issues are available with primary market brokers.

  - Company fixed deposits
Fixed deposit schemes from companies are typically open round the year, unless they have exceeded their collection limits. Even in such cases, companies accept renewal from existing fixed deposit holders.

  - Government schemes
You can invest in RBI bonds directly through the Reserve Bank of India or through a broker. Bit this option is not open for Non Resident Indians. Investments in other government schemes can normally be made through nationalized banks and post offices.

  - Fixed income mutual funds
Fixed-income and money market mutual funds offer investors an exposure to fixed-income instruments. Open-ended mutual funds are available round the year and can be easily purchased/ sold on any business day.

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Contributed by Financial Partners International, Jakarta:
Jasleen Bansal
jasleen.bansal@financial-partners.biz

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