Debt Mutual Funds – Investment snapshot & Tax implications
In the current market scenario, with short term yields remaining quite volatile, it is advisable for investors to be invested in Liquid Plus funds or Short Term Income funds for a 2 months to 1 year horizon as these are the funds that would be able to take benefit of the volatility in short term debt instruments.
Income funds can be reccomended to investors who wish to remain invested in the debt markets for a 1 year plus horizon as we expect long term yields to ease from these levels and Income funds would be in a better position to capture the gains arising out of falling yields due to the funds higher maturity.
Floating rate funds should be considered for investments only in a rising interest rate scenario as these funds would reset their interest rates to the prevaling interest rates.
Gilt funds should be considered for investmnets when there is a high interest rate regime and one expects a steep fall in long term yields. However these funds are more volatile as compared to income funds and would tend to underperform income funds on a risk adjusted returrns basis.
Liquid funds are used by investors only to temporarily park their funds say for a 1 day to maximum 1 month period.
FMP's (Fixed Maturity Plans) are useful to investors who wish to lock in their investments for a specific period at a specific yield. It would be useful when short term yields have hardened considerbly and the investor wants to lock in his investments at that particular yield.
Performance of the Benchmark Bond Indices over various periods:
| | 10 yr | Crisil | Crisil Liquid | I-Sec | I-Sec | I-Sec | I-Sec | CRISIL |
| 1st April 02- | 227.7 | 19.28% | 8.71% | 13.66% | 22.17% | 31.75% | 23.95% | 12.35% |
| 20th Oct 03 | ||||||||
| 23rd Oct 03 - | 334.6 | 6.50% | 13.16% | 12.89% | 5.34% | 0.96% | 5.22% | 10.99% |
| 12th July 06 | ||||||||
| 13th July 06- | 46 | 9.25% | 10.15% | 11.14% | 12.97% | 17.34% | 14.36% | 10.58% |
| 19th Dec 07 | ||||||||
| *The figure in red indicates that the yields have hardened while the ones in black indicate a fall in yields. | ||||||||
It is clearly seen from the above table that
- When the yields have eased, by 227.73bps from 1st April’02 to 20th April’03, the Crisil Composite Bond Index (benchmark for Long term Income funds) and the I Sec MI BEX, Li BEX and the Composite index (Benchmark for Longer tenor G Secs and Gilt funds) have outperormed the Liquid fund and the short term bond indices.
- However when the yields have hardened, by 334.58bps from 23rd October’03 to 12th July’06 the liquid fund and the short term bond indices (both Gilts and Bonds) have outperformed the longer dated bond and G Sec indices.
- From 13th July’06 to 19th Dec’07 when the yields on the 10yr G Sec have remained volatile but eased, short term indices i.e. Crisil Liquid fund Index, Crisil Short term Bond index and the I Sec BEX index (benchmark for short term G Secs) have delivered returns almost in line of the long term bond indices.
| Taxation of Debt Mutual funds | Liquid Funds | Non Liquid Funds |
| Expected Return (p.a.) | 6.75% | 7.50% |
| | | |
| Individual & | | |
| Dividend Distribution Tax * | 1.91% | 1.07% |
| Post Tax Return | 4.84% | 6.44% |
| | | |
| Corporates | | |
| Dividend Distribution Tax ** | 1.91% | 1.70% |
| Post Tax Return | 4.84% | 5.80% |
Note: 1) For Liquid Funds the Dividend Distribution Tax is 28.30% for both individuals as well as corporates
2) For Non Liquid Funds the Dividend Distribution Tax is 14.20% for individuals and 22.66% for corporates
3) Short Term Floating Rate Fund of certain fund houses also come under the Liquid Fund category for taxation purposes.
4) Short term capital gains for individuals are taxed at their individual tax rates while for corporates it is 30%.
5) Long term capital gains for individuals and corporates are taxed at 10% or 20% with indexation benefits
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