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Are fixed income returns fixed?

After SEBI announced changes in rules for fixed income funds, there are apprehensions over returns these funds offer. While returns on liquid funds may get marginally volatile, one is not supposed to

Published: 01st July 2019 02:10 AM  |   Last Updated: 01st July 2019 08:30 AM   |  A+A-

Express illustration. (Tapas Ranjan)

Express News Service

Just like in any sport you have to play by the rules, you have to do the same when investing. The government plays a significant role in being a custodian of your money. It regulates financial markets through regulatory bodies like the Securities and Exchange Board of India (SEBI) for stock markets, Insurance Regulatory and Development Authority for insurance and Reserve Bank of India for banks and non-banking finance companies. In short, the government is the umpire in the investment game. SEBI chairman Ajay Tyagi recently came down hard on mutual funds. After a board meeting, SEBI announced changes in rules for fixed income funds like liquid funds or debt funds. 

Fixed-income funds
These are mutual fund schemes that invest in debt securities issued by the government or companies. These schemes are recommended to you for short-term investments. Fixed income mutual fund schemes usually are positioned as an alternative to fixed deposits. Besides active management of funds, fixed deposit schemes are supposed to be more tax efficient than fixed deposits. A fundamental difference is a tax deducted at source (TDS). Only capital gains tax is applicable for mutual funds. It is lower than the TDS on the interest of the fixed deposit. When you invest, you look for returns on your investment. Nobody wants to lose money. When you buy debt funds, you do so because you have limited or no appetite for losing money.  

Liquid funds 
Liquid funds are short-term funds. Financial planners advise you to put money into liquid funds to build your emergency fund. You need this money for any emergency needs like hospitalisation of a loved one or to meet expenses if you lose a job. The objective of this fund is protecting the value of the money. 
A change in the SEBI rule on the portfolio the mutual fund can maintain for this fund means that returns on liquid funds may get marginally volatile. SEBI has also imposed a graded exit load. 

This means that if you withdraw the money within a week, mutual funds can impose a higher exit load. Those who keep their money longer may pay less or no exit load. As a small investor, you do not have to worry about this new rule. There are multiple reactions from industry experts on potential returns turning negative in liquid funds. However, daily returns matter to corporates more than individuals. By and large, the change of rules in liquid funds is unlikely to affect you. 

Debt funds
Debt funds are expected to offer a steady capital appreciation each year. You are not supposed to lose money in these funds. Although they do not guarantee any return, they are not supposed to turn in negative returns. The logic is simple. If they take money from you and invest in multiple government and corporate bonds that offer a fixed rate of return, there is no reason for you to get a negative return. 

A study published in the latest Financial Stability Report of the Reserve Bank of India says that mutual funds have emerged as a significant source of money for the financial system. When you buy an open-ended debt fund or a fixed maturity plan, they invest a majority of that money in corporate bonds or debt instruments. For open-ended debt funds, it is 93 per cent, while for fixed maturity plans it is 78 per cent, the RBI study said. 

It also highlighted that some debt funds have concentrated holding among debt instruments of a few corporates. It has resulted in some fixed income debt funds generating a negative return. What should you do SEBI is working with mutual funds to ensure a diversification of the debt fund portfolio. It means mutual funds would hold more debt securities to provide stable returns. Mutual funds cannot delay redemption or dividend payments to investors. As an investor, you may want to hold on to only quality liquid funds and debt-funds. While there is no need to panic, you have to come to terms with the fact that fixed income instruments do not guarantee returns. Their returns may vary according to the structure of their debt portfolio.

Tax-efficiency
Fixed income mutual fund schemes usually are positioned as an alternative to fixed deposits. Fixed deposit schemes are more tax-efficient than fixed deposits. A fundamental difference is a tax deducted at source. Only capital gains tax is applicable for mutual funds. It is lower than TDS on the interest of the fixed deposit.

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