Tax-free bonds were almost forgotten in recent months because of the euphoria in the stock market and better returns from bond funds.
Mumbai: Tax-free bonds offering a return of 6.5 per cent are finding favour among rich investors. Stable taxfree returns and lower volatility compared to debt mutual funds are driving investors back to these bonds, traded only in the secondary markets.
“In an era where there is concern whether companies will be able to maintain credit quality, tax- free bonds offer a good alternative for HNI/Ultra HNIs,” says Deepak Jasani, head of retail research at HDFC Securities.
Currently, tax-free bonds of top rated public sector companies offer a yield of 6.4-6.5 per cent. In comparison, fixed deposits from State Bank of India fetch investors 6.25 per cent and interest income is taxable in the hands of the investor. For an investor in the highest tax slab of 30 per cent, the post-tax return on this deposit is 4.31 per cent a year.
Tax-free bonds were almost forgotten in recent months because of the euphoria in the stock market and better returns from bond funds. But they are back in vogue mainly because of the rise in bond yields.
“Given that interest rates could head higher due to rising US rates and higher inflation, investors looking for low volatility options in the fixed income space can opt for tax-free bonds,” said Vikram Dalal, managing director, Synergee Capital.
Within tax-free bonds, Dalal recommends the first series of taxfree bonds issued by PSUs like NHAI, PFC and IRFC in 2012 with a tenure of 10 years that mature in 2022. He advises holding till they mature.
“Investors will have to invest for only four years and can earn a taxfree interest income of 6.1-6.25 per cent,” adds Dalal.
Investors in long-duration debt funds are worried about the negative returns on their portfolio, due to rising bond yields. When yields rise, bond prices fall leading to mark-to-market losses for investors. Data from Value Research show that over the last three months, investors lost 0.4 per cent in income funds, 1 per cent in dynamic bond funds and 2.6 per cent in gilt funds.
In the last couple of years, there has been no notification from the government on issuance of tax-free bonds and hence there is no fresh issue in the primary market. Since there have been multiple issuances by PSU companies in the past, for buying in the secondary markets, investors need to check the exact tenure and interest rate on the bond, said financial planners.
