Consider long-term bond funds for goals that are far away Date: 8th June, 2018

Sundeep Sikka

Sundeep Sikka

ED & Chief Executive Officer
Reliance Nippon Life Asset Management Ltd.

When it comes to financial wealth, every individual typically has three to four aspirations that which are long term in nature. Those aspirations, also called long-term goals, usually span more than two decades and could stretch up to 25-35 years.

The most popular long-term goals could be one or more of the following:

1. Preserving the money one has earned during his working years

2. Leaving some wealth for children and/or grandchildren

3. Achieving life-stage goals like children’s education and their wedding

4. A good retired life for self and spouse

To meet these goals, an individual needs to carefully plan, marry their investments with their long-term goals, and more importantly, earn a certain rate of return over the entire period to reach their long-term objectives.

What are the popular investment options for individuals to meet their long term objectives without taking undue risk? There are at least four options for individuals that meet the twin requirements of low risk and decent rate of return. Let us evaluate each of them to see which one is most suitable for individuals aiming to build a large corpus over the long term.

  1. Tax-free bonds: Till a few years ago, public sector infrastructure companies like National Highways Authority of India, Rural Electrification Corporation, Power Finance Corporation, etc. mobilised money from investors by issuing bonds on which the interest earned was tax free in the hands of investors. For some reason primary issuance of tax-free bonds have stopped. Currently in the secondary market the yield on these bonds range between 6 and 6.50%. Also there is very low liquidity. The longest tenure for tax-free bonds one can get is 17 years (REC, November 5, 2035) yielding just 6%. So naturally for an investor aiming for financial goals that are 20, 25 or 30 years in the future, duration of such bonds are inadequate to meet their requirement. Even if one invests in these bonds, when they mature after 15-17 years, the investor will have to take reinvestment risk.
  2. 10-year bank Fixed Deposits and Reserve Bank of India Taxable Bonds: Of these, an individual can get between 6 and 6.5% on long-term bank FDs and about 7.75% on RBI bonds which are of seven-year tenure. For both, interest earned is taxed as per the investor’s marginal income tax slab.
  3. Public Provident Fund (PPF): A popular long-term investment option backed by government guarantee that offers safety with an attractive, tax-free rate of return currently at 7.6%. It’s a 15-year scheme with an option to extend for five-year block after maturity. However, in PPF one can invest only up to Rs 1.5 lakh in a financial year. Also it is not very liquid since an investor can withdraw only partially after completing six years since beginning.
  4. Long-duration mutual funds: Industry regulator Securities and Exchange Board of India (Sebi) recently standardised all fund categories under which it has allowed for a ‘Long Duration’ category of schemes within fixed income funds. These funds need to have a portfolio duration of more than seven years and hence, will have to necessarily invest in long-term assets.
A case for long-term bond funds

Funds that invest in long-term fixed income assets could well be the answer for those who are seeking investment solutions for meeting their long-term financial goals. For example, consider a fund that invests only into one long-dated Government Security, say, a paper maturing in 2046, that is, after 28 years, and holds that paper till maturity. The fund will, every six months, earn all interest payments from the government, for 28 years and then at maturity, will receive the principal amount. Thus, the fund will earn the current yield, if the security is held till maturity, other things being equal. Also if the underlying investment is held till maturity, it would not be subjected to interest rate risks, whether interest rate increases or decreases. The above paper is currently yielding 8.1%. Post-expenses and taxes, investors could expect about 7% tax-free returns from their investments in such long-term bond funds.

These funds also have high liquidity since the units are bought and sold at Net Asset Value (NAV)-linked prices by the fund house itself. And since these funds invest in government securities and highly rated papers, these schemes are ideal for long-term investments.

Since long-term bond funds invest in long term G-Secs, investors should be prepared for volatility in returns if interest rates move up. Also, in a rising interest rate scenario, like the current market, investors may find other funds, like dynamic bond funds, giving higher returns as they can alter the average duration of their securities.

For the long haul

  1. Long duration funds invest in assets that have more than seven years maturity
  2. If held till maturity the underlying investment would not face interest rate risks
  3. These funds are highly liquid and hence easy to exit if required

Source: DNA