Fixed income in 2022: Stick to the short end to catch the rate upcycle

If the pandemic impacted 2020 started with unprecedented measures — a steep repo rate cut and liquidity infusions — to mitigate Covid-19 impact, 2021 began on a more positive outlook with the economy showing some recovery.

To support growth RBI kept the repo rate unchanged at 4 per cent in February-2021 and continued with its accommodative stance as before. Later, RBI maintained status quo on the repo rate, and towards the latter part, it began taking steps such as halting its bond buying under G-SAP to ‘normalise’ the liquidity injected . This has seen short-term yields, the 91-day, 182-day and 364-day Treasury bill yields go up by 58 to 81 basis points over the past year to 3.7, 4.0 and 4.3 per cent, respectively. The benchmark 10-year g-sec yield has also gone up from 5.9 to 6.5 per cent.

After some softening in July-September 2021, retail inflation surged to 4.9 per cent in November but is expected to ease. On the other hand, core inflation (non-food, non-fuel inflation) rose to over 6 per cent and is expected to persist as manufacturers continue to pass on higher input costs to consumers. In the meanwhile, the RBI continues to retain its 2021-22 real GDP growth projection at 9.5 per cent. But with higher inflation risks, expectations of a rate hike have become stronger than ever before.

Today, it’s best to go for short-term products so that you can reinvest at higher rates sooner rather than later. Or, select floating rate products which let you benefit from a rate hike even as you remain invested.

Fixed deposits

As you bide your time, park your money in short-term bank FDs that can be liquidated later, subject to premature withdrawal rules, for reinvestment. While most debt MFs score over FDs on easy exit — redeemed any time without exit load — given the currently low coupons on bonds, returns from very short duration debt funds are likely to be meagre. The yield to maturity, a broad return indicator, for low duration funds is at 4-5 per cent.

Over the past year, banks have slashed FD rates by at least 15 to 150 basis points (bps). Today, most banks offer 4.9-5.4 per cent per annum on their 1-2-year deposits. But there are some pockets of opportunities here. For example, AU Small Finance Bank’s (SFB) 12-to-15-month FD and Equitas SFB’s 12- to-18-month FD can fetch you 5.85 per cent per annum. Senior citizens get an additional 50 bps.

All bank deposits enjoy DICGC’s insurance cover. After the deposit insurance amendment this year, up to ₹5 lakh — across your savings accounts and recurring and fixed deposits across all branches of a bank — will be returned within 90 days of a bank being brought under any order or direction restricting withdrawals. Investors can also draw comfort from the fact that AU SFB and Equitas SFB are well-capitalised with CRARs of around 22 per cent, well above the mandated minimum of 15 per cent.

Also read: Equity outlook for 2022

RBI floating rate savings bonds

While the 7-year lock-in in the RBI FRSBs can be a deterrent for some, the floating 7.15 per cent per annum (35 basis points over the National Savings Certificate rate which in turn is linked to g-sec yields) makes them worth investing in. Even as interest rates on bank FDs have been slashed, that on the FRSBs has been left untouched including in the latest half-yearly review. As bond yields inch up, the FRSB rate could possibly do likewise. The interest income is taxed at your slab rate, making them especially attractive for those in lower tax brackets.

Target maturity funds

Those with a moderate risk appetite can park some money in TMFs where the maturity of the fund is in line with that of any of your future goals. TMFs are debt funds with a defined maturity that invest passively in the bonds constituting a particular index. They offer return predictability — if you stay invested until maturity. Your indicative return is given by the yield-to-maturity minus the expense ratio. For instance, Edelweiss MF’s BHARAT Bond ETF - April 2025 can fetch you a pre-tax return of 5.65 per cent. A flat 20 per cent tax (with indexation benefit) on capital gains on sale of units held for over 3 years makes them more attractive than FDs for high-tax individuals.

Most existing TMFs come with a maturity of four years and upwards. Parking large sums in long maturity TMFs until maturity may mean losing out on the chance to reinvest at higher rates, going ahead. So, limit your investments.

On the other hand, premature exit can expose you to capital loss (fall in the price of existing bonds in the fund portfolio) as interest rates move up.

Listed NCDs

Those with a higher risk appetite, can invest in AAA and AA+ rated listed NCDs (non-convertible debentures) or bonds maturing in the next 1-2 years for better returns. Based on data compiled by HDFC Securities, the AAA-rated Tata Capital Financial Services NCD — with a residual maturity of 1.84 years and yield to maturity or return of 6.67 per cent (data as of Nov-end) — is a good option.

Given the tax on interest, NCDs make most sense for those in the lower tax brackets. You can buy them through your brokerage account or on platforms such as Bondskart and BondsIndia.

Also read: Gold outlook for 2022

What next

As you invest, ensure that part of your corpus can be liquidated easily as other higher-return options emerge. For instance, many AMCs have filed for new TMFs with SEBI. These could offer better returns if yields move up between now and their launch. You can also sign up for an RBI Retail Direct Account to invest in GOI debt papers at no charge. You can start by buying GOI T-bills. Your return or interest is given by the differential between the issue price (below face value) and the redemption at face value. With T-bill yields likely to move up further, these can be a good investment in due course.