Why it makes sense to invest in Nabard's tax-free bonds

Lock into these long-term bonds for higher interest rates and capital appreciation

If worried about recent volatility in the stock markets and the prospect of a rate cut by the Reserve Bank of India, you could consider Nabard’s tax-free bond issue, which will open for subscription on March 9. The development finance institution is looking to raise Rs 3,500 crore, of which Rs 2,100 crore will be for retail investors.

For retail investors – those investing up to Rs 10 lakh - the coupon rate is 7.29 per cent for 10 years and 7.64 per cent for 15 years. The interest will be paid annually.

For non-retail investors, the coupon rate is 7.04 per cent for 10 years and 7.32 per cent for 15 years. Nabard has a ‘AAA’ rating from rating agency CRISIL. Should you invest in them considering that this is likely to be the last tax-free bond issue this financial year?

According to Feroze Azeez, deputy CEO, Anand Rathi Private Wealth Management, investors should choose the 15-year option. “Interest rates are expected to soften going ahead. So, investing for 15 years will give fetch you good capital appreciation. And, since the coupon rate for the 15-year option is higher, accruals will be higher, too,’’ he says.

For retail investors, the effective yield would work out to 10-10.5 per cent for someone in the highest tax bracket. In comparison, a 10-year bank fixed deposit (FD) offers 7-7.5 per cent interest, taxable according to your slab.

"With interest rates on bank FDs coming down, this is a fantastic opportunity for retail investors to lock into fixed interest for the long term. But, liquidity is an issue. So, if you can take equity risk, then investing in equity mutual funds is a better option because over 10-15 years, equities will never disappoint,’’ says Tanwir Alam, CEO, Fincart.

According to Manikaran Singal, a Sebi-registered financial advisor and founder of Good Moneying Financial Solutions, it does not make sense to lock in money at these rates for a 10- or 15-year period. “When interest rates fall, you can get higher capital appreciation from open-ended debt mutual funds.

However, check the portfolio of the mutual fund before investing. If you have low risk appetite, go for tax-free bonds. But, if you want high returns also, then opt for debt MFs.” While agreeing that debt funds also give capital appreciation, Azeez says that the fees charged by these funds eat into the returns. “Even if the bonds offer 7.5 per cent returns, the fees range from 1.5 to two per cent. This impacts the returns,’’ he says.

Another problem with tax-free bonds is that while a certain portion is reserved for retail investors, it is difficult to get allotment. Often, retail investors don’t get more than Rs 1 lakh worth of bonds in each issue. They are, then, forced to invest in several tax-free issues. Then keeping track of all of them becomes difficult, says Singal.

Redeeming or selling these bonds before maturity is another issue. While there is a window for selling tax-free bonds, in the secondary market, the volume of trade is negligible because the bond market in India is not well developed, says Alam.

But, Azeez points out that over the past six to eight months, liquidity and trading volumes have been higher because of falling returns. So, retail investors looking to sell should not find it difficult to find buyers.

“Tax-free bonds have garnered a lot of investment this year. Next year, there may be fewer issues. That is why this is a good opportunity to invest in them.”