Year-end deals on short-term debt funds

FMPs and short-term income funds are good options as the rates are high at this time of the year.

Every year, March is typically a time when short-term money market rates start to peak. This happens because fiscal-end demand for funds increases. This presents a good opportunity to risk averse investors to take advantage of the tightness in short-term rates.

Where to invest?

Short term in this case means one to three months. If you compare three-month certificate of deposit (CD) and commercial paper (CP) rates with 12 month rates of CDs and CPs, in most months the latter will give a higher return. In March, however, with three month CDs offering 9.5% and 12 months giving 9.3%, the tables have turned.

Open ended funds: For a retail investor, it doesn’t make much sense to buy these securities directly as the minimum investment threshold can be very high. What you can do is consider investing in ultra short-term and short-term income funds which currently invest primarily in bank CDs or, if available, short-term fixed maturity plans (FMPs) which have a portfolio comprising purely of bank CDs. The difference between a FMP and an open-ended income fund is in the way the portfolios are managed. An FMP is a locked-in product where the tenor matches the maturity of underlying securities and your earning will match the yield earned on them. An open-ended actively managed debt fund can also give you the benefit of capital appreciation as the fund manager is able to sell a security in a falling rate scenario and book profits. Open-ended structures which invest in slightly longer (more than three months) tenor securities but with attractive yield can also benefit from increase in prices if yields fall in the next two-three months. According to R. Sivakumar, head–fixed income and products, Axis Asset Management Co. Ltd, “Open-ended structures can work better since the yield differential compared with short-term securities is not too high and at the same time there is room for slightly higher return for investors."

The current annualized return for actively managed ultra short-term and short-term income funds is averaging around 10%. If you fall in the highest tax bracket of 30.9%, post-tax return on six-month fixed deposit can be 5.0-5.5%. At the same time if you opt for the dividend distribution option in an income fund, then you will have a tax deduction at the rate of 25% (plus surcharge and cess) and post-tax returns of around 7% annualized. There are exit loads in open-ended funds, so look for those which have a 25-30 day exit load if you need near-term liquidity.

Double indexation FMPs: Thirteen-month FMPs, invest in money market securities with 12-13 month tenor and deliver yields commensurate to interest available on such securities. Says Surya Bhatia, managing partner, Asset Managers, “The opportunity exists as around this time liquidity tightens and rates creep up, by April they come back to normal. One can invest in ultra-short term funds with a 1-3 month horizon and take advantage of mark to market gains and yield. At the same time there are FMPs with double indexation benefit."

The specific advantage of such funds is the double indexation benefit, since they technically span two fiscals, being issued in the last month of FY13 and redeemed after 13 months in the first month of FY15.