April 27, 2007

Fixed income investing

My blog and most of my posts refer to equity investments. I have once in a while posted on real estate. However fixed income investments are a fair percentage of my portfolio. The reason I don’t post much on fixed income investments is because there is not much I can do to generate extra returns in proportion to the time and effort I will have to spend on it.

The fixed income options available to me are

- Bank FD : this is almost a no brainer and the most passive form of investmtent. However I don’t chase returns blindly. I typically hold deposits in only the Top banks and avoid the second tier banks and co-operatives. The extra 1-2% return is not worth the risk. In addition, I tend to look at the capital adequacy ratio (CAR) and the NPA levels of the bank, before going ahead with the FD. The name or reputation of the bank alone is not sufficient. Typically the CAR levels of the bank should be above 8-9 % (TIER I) and NPA levels below 1-2 %.

- Company bonds : The next avenue for fixed income investing is company bonds. I have invested in company bonds and FD’s in the past when the interest rates were higher and it was possible for me to process the paperwork. However since 2000, partly due to the amount of paperwork involved then (there was no Demat for bonds) and due to the easy of investing in mutual funds , I stopped looking at company bonds and FD’s. Also due to the high profile failure of some of the companies and the losses incurred by the bondholders, I kind of lost interest in company FD’s and bonds. The key factors to look at when investing in such instruments is the interest coverage ratio ( PBIT/ Interest expense ) which should atleast be 4, Debt equity ratio for the company ( < 0.5 if possible) and debt rating by the rating agencies such as Crisil (invest in AAA or AA+ only).

- Mutual funds – fixed income: This is my favored avenue during a falling rate scenario and I tend to invest with well know mutual fund houses such as franklin templeton, DSP etc. At the time of investing in a debt mutual fund, I tend to look at the following factors
o Asset under management – avoid investing in funds with low level of asset as the expense ratios could be high.
o Fund expense – lower the better. Although the indian mutual fund industry typically gouges its customers and charges too high compared to the returns.
o Duration of fund – This is the average duration of the fund. A fund with longer duration will rise or fall more when interest rates change
o Fund rating – 80-90% of the fund holding should be in p1+ or AAA / AA+ securities.
o Long term performance of the fund versus the benchmark

- Mutual funds – floating rate funds : This is my favored approach in a rising rate scenario. In addition to all the factors for the fixed income mutual funds, I also tend to favor floaters with shorter duration.

- Post office : Nothing much to analyse in this option other than it was an attractive option a few years back when the Post office offered better rates than available in the market. Currently the 8-9% per annum for the 6 year duration is not attractive enough.

- FMP (fixed maturity plan) : I have just heard about it and have yet to understand about this investment option.

Finally in terms of tax effectiveness, debt based mutual funds are the most efficient as they are subject to long term tax rate after 1 year.


Prem Sagar said...

Hi Rohit,
I havent had much exposure to debt funds. (started earning in 2003 and a strong mkt influenced me to stick mainly to equity funds)..
In addition to ur points, floaters are also good in sense they give a daily interest compared to FDs which cant be broken without losing interest.

This is my understanding of FMPs.
1. They are held till maturity and are less exposed to interest rate movements.
2. Most of them are offered just around March so that one can benefit from double indexation.
3. Unlike bonds and FDs, you can pay tax at 10% without indexation or at 20% with indexation (for long term gains). However, I need confirmation on short term gains.. I think its taxed at ur slab, making the dividend option favorable inspite of the recent DDT hike for high slab ppl.
4. Low cost arising from the fact that they dont need regular checkup as they are held till maturity.
5. As far as I know, they are close ended from 90 days to a yr or more.
6. The managers invest in instruments that will mature around the same time the scheme matures.

Prem Sagar said...

And what are your thoughts on balanced funds that have performed well like HDFC Prudence that have a significant fixed investment portion... they are considered like equity funds for tax after 1 yr. You end up paying 0 tax. You can reasonably balance your folio using these..

However, I prefer to keep them separate. Dont like to mix things.

Rohit Chauhan said...

hi prem
thanks for the clarifications on fmp plans. on face of it they dont appear to very attractive, but maybe i havent analysed them in detail.

i used to invest in balance funds earlier ..but stopped doing that later. i though that i could get the best of both worlds - debt and equity . in the end i ended up getting the worst of both

for ex: in 2000 most of balanced funds i invested in were in tech stocks and by 2003 they were in debt. ideally if the fund managers were rational and not following the herd, they should have done the opposite (i would expect them to do better than the average if i am paying them)

so now i am mostly into diversified equity and debt funds and manage the mix on my own

Prem Sagar said...

I have a question for you.

Do you believe in multiple sources of income or in a major source where you focus on most of the time?

Where does career stand in the process of creating wealth?

No of hours in learning for career growth and in learning investing: How would you balance it? Would you focus on the former or latter?


Ketan said...

Hi Prem, pretty interesting comments from you... Rahul I am taking the liberty to put my thoughts here....

I think creating wealth is an ongoing process... like water... if it stagnates.. it stinks... even when you retire.. your money should not....

Where career can or can not be an vehicle for creating wealth... Also creating wealth is a subjective thing where you need to decide the limit..... because wealth creation should be done with some purpose...

There is no point in spending your entire life creating wealth if the life just passes by you... what will you do with crores of ruppees in ur kitty if you cannt move your body due to old age... It is important to enjoy the wealth while creating it.. and that is why you need to put a limit of how much and when....

Multiple source of income is good.. but a career is not usually only for wealth creation... I work not because i get money (ofcourse that is main thing) but also becoz i get sense of achievement and a sense of respectability in society... thats what is called job satisfaction...

Even though career is ur prime earning source... it depends on what gives you satisfaction.. where you feel the passion... i have always witnessed that the work in which you are passionate about will bring you wealth...

May be it might sound like personal rambling.... but i guess ur question is too subjective...

Rohit Chauhan said...

i agree with ketan on a lot of points.

investing is a passion for me. i does enhance my networth and that is one of the key objectives, but not the only one. how i do it is as important as the returns.

for example, this website from a financial standpoint is a wash. i dont make much out of it , but i still do it after 3-4 years because of my interest in investing, business and learning.

for me career currently provides me the raw material (starting capital) to invest, provides for my family. investing for me is a passion and also enhances my networth.

i personally am not looking at multiple income streams. for me time is a more limiting factor than money. more so because my financial needs have always been limited . so in the end i prefer to do what i find enjoyable rather than from a solely financial standpoint.

for ex: starting a business or dabbling in real estate could help me making more money. but i have no interest in either. i eventually would lke my interest in investing to somehow be a career option, but that is some time off.

Ketan said...

My mistake... wrote "Rahul" instead of "Rohit" ;-)

BTW both of you have very good blogs... added the links to my blog

Prem Sagar said...

Hi Rohit and Ketan,
I liked this line..."creating wealth is an ongoing process... like water... if it stagnates.. it stinks"

Agree with this.
"The work in which you are passionate will bring you wealth"

Am trying to work on identifying what I need and how much and things like that...I am gradually shifting towards wholesome living...something like the wheel of balance talked about in 'First things first'. Want to enjoy life while working/earning/living. want to identify what I truly enjoy and make that my 'work'

I personally like multiple sources of income...but salary is the main source of income today. Going forward, i intend to have a few more.

Career to me gives
1. Money
2. Social position (which I dont like to care for, but hypocritically like it)
3. Sense of satisfaction in doing something useful/create value

I believe in expertise and not being a jack of all. So leveraging some skill to create wealth is a key area for me to look at.

As far as a business is concerned, I love to own one! But lack of certain entrepreneurial skills scare me! As of now, that involves too many 'variables' which I cant fathom.

As far as passion and career merging together, like Rohit says, I too would like to have investing as a career... but given the freedom to choose, I would select being a business owner.. of course that is with today's maturity and thinking..and can change anytime.