Fixed deposits and tax-free bonds can be better alternative to IIBs.
To discourage investors from buying gold, RBI launched inflation index bonds which were meant to provide a hedge against inflation.
After RBI launched these bonds last year, DWS, HDFC and SBI have launched their Inflation Index Bond Funds which exclusively invest in these bonds. Axis Mutual Fund too has filed an offer document with SEBI to launch its inflation index bond fund.
Let’s take a closer look at these bonds to figure out whether you should recommend these funds to your clients.
Inflation Indexed Bonds (IIB) are issued by government that have coupon and principal linked to inflation. Having a tenure of 10 years, these bonds are linked to Wholesale Price Index (WPI). For instance, if these bonds are available at yield of 3% above WPI, and WPI for full year is 7%, IIB will offer a coupon rate of 10 % (7%+3%) in that year.
Merits
Capital protection
Not only these bonds offer safety of principal, these bonds can offer capital appreciation if the rate of inflation increases. “With the present volatility in the gold prices, investment in gold may not offer any capital protection. So, these bonds will help investors to safeguard the principal amount and receive the yield based on the prevailing inflation,” says Vishal Dhawan of Plan Ahead Wealth Advisors.
Low Risk
These bonds are ideal for risk averse investors. Further, since these bonds are backed by the government and are as safe as other sovereign bonds.
Demerits
Better alternatives
Fixed deposits and tax-free bonds are better alternative to IIBs. Tax free bonds provide fixed interest throughout the term. Contrary to this, the return from IIBs are dependent on the rate of inflation. “As these bonds are linked to WPI, in periods of lower WPI, these bonds will give lower returns as compared to the other traditional 10 year bonds,” says Shifali Satsangee of Funds Vedaa.
Taxation
IIBs are treated like debt funds for taxation. These bonds are suitable for investors falling in lower tax bracket (up to 10%).
Should you recommend IIBs now?
Financial advisors say that this is not an ideal time to invest in IIB. “Investing in IIB may not be advisable now as these are linked to WPI. Further, commodity prices are unlikely to increase soon, thereby leading to lower WPI and lower returns on bonds,” adds Shifali.
Vishal Dhawan of Plan Ahead Wealth Advisors feels that IIBs can be a success in the long run. “The demand for these bonds is low mainly because of lack of awareness. Inflation index funds can offer better returns as compared to tax-free bonds if interest rates continue to go up. About 10% to 20% of the client’s portfolio can be allocated towards these bonds.”
Hemant Rustagi of Wise Invest Advisors says, “Inflation Index funds have not caught the fancy of investors yet. The funds may beat inflation at a gross level but after paying expense ratio and tax the returns would be less. The returns could go down as inflation falls. Investing through mutual fund route is better because you don’t have to lock in money for ten years. Tax free bonds may look attractive but there is no compounding benefit.”
