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GoI Relief Bonds - Top Fixed Income Flavour

Despite marginal liquidity and a five-year tenure, panic stricken investors have been pouring investments in GoI Relief Bonds. The tax-free returns have come as icing on the cake

The debt funds are facing stiff competition from an unlikely quarter – Government of India Relief Bonds. Armed with an assured tax-free return of 8.5 per cent, the bonds have caught the fancy of scores of individual investors and high networth investors. Despite a five-year tenure with marginal liquidity, investors have been queuing up to invest in the instrument and lock-in at attractive yields. Inflows into GoI bonds have gained further momentum after the recent crash in both equity and debt markets post-WTC bombing.

The distributors are not far behind – they have quickly shifted loyalty from debt funds to GoI Relief Bonds with thick upfront incentives adding to their sales pitch. Private sector banks like ICICI Bank and HDFC Bank have taken the lead in aggressively selling these instruments. Suddenly, fund houses discover that the virtues of a bond fund like instant liquidity, service standards and transparency are not finding many takers.

According to data provided by the Reserve Bank of India, investments in GoI Relief Bonds have soared to Rs. 4,086 crore in the first four months of the current fiscal against Rs. 1,201 crore for the first quarter last year. The inflows have come even though the assured return was cut by 50 basis points from March this year. On the other hand, net investments in bond funds (excluding cash funds) have seen a sharp slump in the last two months after large inflows of over Rs 5,000 crore in June. While AMCs are surely feeling the pinch, corporate investments continue to flow in the debt fund category since companies cannot invest in relief bonds.

"Yes, relief bonds are being sold like hot cakes,'' says Nilesh Shah, chief investment officer, Templeton India Asset management Company. "Lot of money is flowing into GoI Relief Bonds and we are facing a stiff competition, especially after US attack. Investors are first putting money here and then talking about other options," says the regional head of a private sector AMC.

Hardly Comparable…
The two products are hardly comparable but the market dynamics have pitched bond funds against relief bonds. While relief bonds offer an assured income, returns are not guaranteed in bond funds. Further, debt funds are strictly linked to the vagaries of the bond markets but relief bonds are absolutely insulated from yield movements. Liquidity or ease of redemption is also a key differentiating factor – bond funds offer an instant exit option. On the other hand, relief bonds are hardly traded in the secondary market though their availability in demat form could enhance liquidity.

Last but not the least; the tax-free returns from relief bonds is also enticing investors, especially HNIs. For instance, for an investor in the 30 per cent tax bracket, the yield works out to an impressive 12.14 per cent. "You are not getting this kind of return anywhere in the country,'' says Shah. On the other hand, dividend income from bond funds is subject to a tax of 11 per cent.

The Flight to GoI Relief Bonds
Despite an average one-year return of 16.2 per cent from debt funds for the year ended August 31, 2001, why are investors showing a preference for GoI Relief Bond? For one, after the US-64 fiasco coupled with the mess in other government owned financial institutions and co-operative banks, investors are scouting for absolutely safe investments. With relief bonds backed by the government, fresh investments are piling up in these securities. The sharp losses since 2000 on equity investments has only seen returns being compromised for added safety.

The unbridled bull-run in bond markets has also ebbed and hence, the phenomenal gains of recent past are likely to taper off. "While safety is the prime motivator, investors are also unsure whether the rally will continue with yields touching historical lows,'' says a distributor of funds. The recent spate of volatility in bond markets has only further driven investors to relief bonds. For instance, bond funds dropped by an average 1.35% on Monday but gained a total of 0.77% in the next two days. Clearly, the risk-averse debt fund investor has not taken kindly to these gyrations.

While gains by way of appreciation are on the decline, returns from interest income will also go down since the entire interest rate paradigm has shifted downwards by at least 200 basis points. "An encore is unlikely. Now the coupon will be on a lower side and our target return will be in the band of 8.5 to 9 per cent,'' points out Shah.

Industry sources now hope that the government may be forced to cut the coupon on the bonds. "The current return is not in sync with the prevailing interest rates. While the yield on a 5-year government security is only around 7.9%, the bond offers a tax-free 8.5%. Clearly, the government is unnecessarily adding to its debt burden,'' says an industry source.

The Right Choice
Should you opt for relief bonds or invest in bond funds? Well, the two products are poles apart. If you can forego liquidity on your investment for five years, invest in relief bonds. For one, they are one of the safest options available and two; provide tax-free returns. However, it is unlikely that liquidity will pick up in these bonds in a big way. Further, while interest rates have been on the decline, what happens if the trend reverses? Although a remote possibility, a rise in interest rates cannot be totally ruled out and you would stuck with lower interest income. On the other hand, debt funds mirror the markets with fluctuating returns but with the convenience of easy entry and exit. Thus, You can alter your investment strategy in line with market movements. Or, if you need invested capital 1-2 years down the line, debt funds are the best investment vehicle.

How They Not Compare….
  Parameters  RBI Relief Bonds  Debt Funds
  Credit Quality Highest Variable
  Returns Assured Not Assured
  Tax-Efficiency Tax-free 11% dividend tax
  Liquidity Iliquid* Highly Liquid
  Volatility Nil Moderate
*Five-years tenure