Debt Fund Yields are Attractive
- RBI has been increasing interest rates since May 2022 to reduce inflation
- Cumulatively, the repo rate has been raised by 250 bps so far
- As a result, the government bond yields have risen sharply in the last year and have become attractive especially in the 3-5 year segment (yields around 7.2%)
Yields close to peak levels – Opportunity for higher future returns (compared to last 3 years) if yields remain stable or come down from here
- RBI may pause from hereon or go for another minor rate hike in next policy. This is driven by
– India’s CPI inflation, though above RBI’s tolerance band (2-6%) at 6.44% for Feb-23, has eased from peak level of 7.79% in Apr-22
– Current repo rate (at 6.5%) is comfortably above RBI’s inflation expectation (5.3% for FY24)
– Concerns over global growth slowdown
– US inflation also continues to ease and the Fed has slowed down the pace of rate hikes
- Future rate actions will be guided by the evolving domestic inflation / growth dynamics and the US Fed rate hike trajectory
- In our view, we are close to peak yield levels
- The current yields provide a sufficient buffer for higher returns over a 3+ year time frame even if yields were to temporarily inch up further leading to near term volatility
- Further, any fall in yields could result in bond prices going up. This could lead to some extra returns from your debt fund portfolio.
Invest in Debt Funds before 31-Mar-2023 to get indexation benefits…
- Based on the amended Finance Bill 2023 passed on 24-Mar-2023, gains from new investments made after 31-Mar-2023 in Debt Mutual Funds will be taxed as per your individual slab rates irrespective of the holding period. Currently, gains from Debt Fund investments less than 3 years are already taxed according to your tax slab, but those beyond 3 years are taxed at 20% after indexation.
- Impact: This may lead to lower debt fund post tax returns (~1 to 2% lower) for 3 Year+ investments if invested after 01-Apr-2023
- However, you can still get indexation benefits in debt funds if you invest on or before 31-Mar-2023 and hold for more than 3 years.
- Further, investing now could help you claim indexation benefit for an additional year.
- For example: Assuming 7% returns, a Rs 10 lakhs investment made before 31-Mar-2023 (FY23) in a debt fund and held atleast until 01-Apr-26 (FY27) is likely to offer a post tax return of 6.9% (vs 5.0% if invested after 31-Mar-23)
- Though your investment horizon is only slightly longer than 3 years, you get to enjoy indexation benefits for four years as your investments are held across four financial years (FY23 to FY27).
- So, if you are already planning to invest in debt funds, do it by 31-Mar-2023 to get indexation benefits (if held for more than 3 years).
Where to invest?
We prefer open-ended debt funds with
- HIGH CREDIT QUALITY (>80% AAA exposure)
- SHORT DURATION (1-3 years) or TARGET MATURITY FUNDS (3-5 years)
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