Home >Money >Personal Finance >HNIs switch to bonds, REITs to deal with interest rate squeeze

With fixed deposit (FD) rates and debt mutual fund yields unable to compensate for the rise in inflation, high net-worth individuals (HNIs) are slowly migrating to other alternatives. FD rates in most of the banks is in the 4-6% range even as inflation has been above 6% since April 2020. The yield-to-maturities (YTMs) on debt funds are also not enough to match inflation.

As a result, instead of FDs and debt funds, HNIs are now relying on market-linked debentures (MLDs) and direct buying of standard high-yield bonds, apart from looking at other alternatives such as real estate investment trusts (REITs) and infrastructure investment trusts (InVITs), according to wealth managers.

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MLDs (also called structured products) have emerged as a popular route for HNIs, according to wealth managers. These are basically bonds issued by non-banking finance companies (NBFCs) but also have payouts linked to the equity markets. For example, an MLD might offer a return of 8% if the Nifty closes below 16,000 levels in the next three years, 10% if it closes between 16,000 and 18,000 and 9% if it closes higher than 17,000.

The equity linkage allows listed MLDs to enjoy a tax advantage. If they are sold after a holding period of more than a year, they are subjected to a 10% long-term capital gains (LTCG) tax. For shorter holding periods, short-term capital gains (STCG) is taxed at the individual’s marginal slab rates.

The nature of MLDs, however, has become more debt-oriented over the past year, say wealth managers. The equity linkage is retained as a formality, in order to get the regulatory approvals required for the MLD to be listed on a stock exchange. For instance, a condition like 5% return if the market falls below 7,500 may be placed and 8% if the market stays above this level in the next three years may be specified. This makes a return of 8% almost a certainty.

MLDs are usually arranged by a wealth manager or broker although issued by an NBFC. The MLD is listed and this broker or wealth manager buys the MLD from the investor close to maturity. As a result, the investor’s return from the MLD takes the form of LTCG rather than interest taxable at slab rate, which would be the case if the MLD is held to maturity.

“In the HNI segment, there has been a definite shift from debt mutual funds to direct bonds purchases. These can be MLDs or non-convertible debentures (NCDs). AAA-rated bonds yield around 7.5% and AA-rated ones yield about 8.5%. If you combine the tax efficiency of an MLD with the yield, investors get a good post tax return," said Atul Singh, chief executive officer, Validus Wealth Managers Pvt. Ltd. “MLD issuers in April-May during the height of the covid-19 crisis were big-label corporates like Tata, Birla and Mahindra & Mahindra. Thereafter, investors shifted to gold finance companies and now to vehicle financiers on the back of good auto numbers," he added.

According to Anand Rathi, founder, Augment Capital Services LLP, buying attractively positioned bonds on the secondary market is another popular strategy among HNIs. Wealth managers scout for these on behalf of their clients, he said.

Yields on many large issuers spiked in April and May, but the Reserve Bank of India’s liquidity programmes have brought these down steadily since then, pushing up the returns for savvy investors who waded into the market at that time. For instance, Shriram Transport Finance Ltd (STFC) bonds which traded at yields close to 14% at the height of the covid crisis have come down to 8-9%. A fall in yield is associated with a jump in the price of the bond, thereby producing gains for any investor who wishes to sell it in the secondary market.

other alternatives

Some investment professionals are also suggesting REITs and InVITs to their HNI clients. “Apart from MLDs and secondary market debt, we have also suggested REITS and InVITs to our HNI clients. These have dividend yields of around 7-8%, say for Embassy Office Parks, to 9-10% for Indigrid InVIT. Dividends from REITs and InVITs are tax-free in the hands of investors," said Prateek Pant, co-founder and head, products and solutions, at Sanctum Wealth Management, which distributes mutual funds. A REIT invests in commercial real estate. An InVIT invests in infrastructure projects such as power transmission lines or roads and highways. Both REITs and InVITs are required to distribute at least 90% of their cash flows to the investors.

Unlike a bond, there is no guarantee of principal repayment in them. Instead, their net asset values (NAVs) fluctuate according to the appreciation or depreciation of the underlying asset. To know more about REITs, read and

REITs and InVITs tend to invest through special purpose vehicles (SPVs) and if the SPV has not opted for a concessional rate of corporate tax, the dividend distributed by REIT or InVIT becomes tax-free for the unitholder. Apart from dividends, capital gains tax comes into play when an investor sells the REIT or InVIT. If the investor’s holding period is less than three years, the capital gains in these products are taxed at 15% and if it exceeds three years, capital gains are taxed at 10%.

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Not all investment professionals are comfortable with these options. “High-yielding low-rated papers face immense liquidity risk, which came to the fore when Frankling Templeton Mutual Fund wound up six of its schemes in April 2020. A cash crunch in the MSME (micro, small and medium enterprises) segment can lead to huge stress on the issuers’ balance sheet. Thus, it advisable to avoid any concentration risks in AA-rated and below-AA-rated segment at this moment till the economy completely revives," said Rushabh Desai, a Mumbai-based mutual fund distributor.

Vishal Dhawan, chief executive officer, Plan Ahead Wealth Advisors, a Sebi-registered investment adviser, concurred. “Issuer risk is important in both MLDs and direct purchases of ordinary bonds, as the recent Laxmi Vilas Bank (LVB) bonds write-down has shown. Investors dipping their toes into this should really know what they are doing," he said. Tier II bonds issued by LVB were written down in the RBI-led rescue of the troubled bank.

Retail investors and risk-averse HNIs may be better served by mutual funds which are more diversified vehicles. Some mutual fund categories further minimize risk by investing in only certain types of bonds. For instance, corporate bond funds have to invest 80% of their assets in bonds rated AA+ and above, while banking and PSU debt funds have to invest at least 80% of their assets in bonds issued by banks and public sector undertakings.

Consider the risks in MLDs, REITs, InVITs and other similar instruments before buying them to get higher interest rates.

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