Are you invested in Tax Free Bonds and sitting on good profits? It is time to book the profit and invest in Sensex or Nifty Index ETF’s as the returns on ETF’s will be much higher than tax free bonds going forward. However, this switch would have to depend on your risk appetite and if you do not know your risk appetite, send us a Tweet @right_mf and we will send you a risk form for you to find out your risk appetite.
A simple calculation can show you why it can be a good risk taking opportunity to shift from tax free bonds to Index ETF’s.
Assume you have invested Rs 100 in 10year tax free bonds at an yield of 8%. The yield on the bond is now around 6% and the price is around Rs 112. If you hold the bond, you will get 8% tax free every year, which by itself is good compared to today’s yields of 6.5% to 7.3% across fixed income securities.
If you are content with 8% tax free, do nothing and stay invested.
If you are looking for an opportunity to book profits, then sell the bond at Rs 112 and invest in Sensex or Nifty ETF. If the indices rise even 10%, then your capital grows to Rs 112 plus 10%*Rs 112 = Rs 123.2, whereas if you stay invested in tax free bond, your capital stays the same at Rs 100 and you receive Rs 8 as coupon income.
You need to understand that the switch is from one asset class from equity to debt. A switch from debt to equity should be done only if your asset allocation permits.
You would have to have a view that interest rates have bottomed out in the economy and equity will outperform bonds in the next few years if you want to switch out of tax free bonds into equities.
Taxfree bonds of more than Rs.128,000 Crores were issued and subscribed by investors between financial years 2012-2016.
Most of the issues were of Public Sector Units and were highly rated like National Highways Authority of India Ltd (NHAI), Power Finance Corporation (PFC), Indian Railways Finance Corporation (IRFC), Rural Electrification Corporation( REC), National Thermal Power Corporation (NTPC), National Housing Bank (NHB), Indian Infrastructure finance Company ltd (IIFCL), National Bank for Agriculture & Rural development (NABARD), National Hydroelectric Power Corporation ltd (NHPC ), IREDA, Kamarajar Port , HUDCO, Ennore Port & JNPT.
Majority of the issues were AAA rated with some of them being AA+ & lowest was AA rated.
The coupons of these issues for investors were at high levels,the highest coupon was for 20 year bond for AAA rated NHB issue @ 9.01%.
The lowest coupon bond was AAA rated REC , 20 year bond at a coupon [email protected]%.
The coupon of taxfree when they were issued were benchmarked to yields of government securities of similar maturities. For AAA rated securities the yield could be 0.5% lower than Gsec of similar tenure for retail investors & 0.8% lower than GSec yield of similar tenure for other investors.
ForAA + the coupon could be 0.1% higher & for AA & AA- investors the coupon could be 0.2% higher.
These bonds were offered in public and private issues and were subsequently listed on the stock exchanges.
Awareness and understanding of the secondary markets in the debt segment is low. Volumes are lower as retail investors typically buy and hold the bond upto maturity.
Despite the low awareness, transactions do happen in many taxfree bonds and retail investor can sell their bonds if they want via offering it on the stock exchanges or via brokers who deal in them offline.
Interest rates in the system have trended lower in the last one year. 10 year Gsec yields have trended lower and has fallen by around 1.3% , currently trading @ 6.53%..
The sharp fall in interest rates has resulted in fall of taxfree bond yields.Accordingly 10-15 year taxfree bonds are also trading at lower yields at close to 6%.
For eg NHAI series NE , retail , maturing on 9th march 2031 is trading at Rs1173 per bond. The face value of the bond is Rs. 1000 a gain of 17.3%.
The difference of Rs 173 will be treated as capital gains taxed as capital gains at 10% plus surcharge without indexation benefit as long as the holding period is more than 1 year.