Tax-free bonds are debt instruments through which Public Sector Undertakings (PSUs) like NHAI, NTPC, REC in India raised money (through Public Offers that came in between FY12 and FY16). These were issued for a long-term maturity of around 10, 15 or 20 years. As the name suggests, the interest earned in these bonds is tax free in the hands of investors and hence does not add to their overall tax liability.
Such tax free-bonds are currently available at yields of 5.6-5.7%, and are an interesting investment option especially for investors falling in the 30% or higher income tax bracket as the pre-tax yield for these investors on these bonds will work out to ~8.1-9.8% (depending on Slab and Surcharge applicable) and, hence, work out to be a lot higher than any other debt option currently available in the market, including bank fixed deposits, RBI Bonds etc. The investor also gets the added benefit of lower risk as the issuers are PSU companies.
Since the downgrade and subsequent default of IL&FS in Sept' 2019, Indian Bonds markets has been riddled with high level of turmoil fuelled by an unforeseen number of credit events, including rating downgrades and credit defaults within debt securities, some of which were rated AAA (highest possible rating ) as per the rating agencies. This has taken many debt investors by surprise as they had always perceived debt instruments to be completely safe until then and had never anticipated the possibility of capital erosion in the same.
This along with the drop in bond yields, driven by the 135 bps rate cut by the RBI, has led the investors to look for safer investment options with low volatility wherein they can lock in the yields for a long term. This is exactly where the Tax-Free bonds fit and hence have regained prominence in the last few quarters.
Routes to buy Tax Free bonds
The government in FY 2015 did the last primary issuance of tax-free-16 and no subsequent fresh issues have hit the market since then. Therefore, this effectively leaves the investors with the option of buying these bonds from the secondary market only – hence are available on NSE/BSE for trading.
For any retail investor having an existing trading /demat account, he/ she can purchase the bond from the exchange like an equity stock on basis of the availability. In cases where the traded volume of the desired bond is low, the investor might have to do multiple transactions over the 2-3 days to buy the required quantity. Alternatively, investors seeking to purchase bigger quantum can reach out to their respective wealth managers. The investor just needs to be cognizant of the credit quality and the YTM (and not coupon) of the bond.
Since most of these bonds pay interest annually, investors looking to fulfil their regular income (at multiple times during a year) requirement though the bond proceeds can do so by investing in multiple bonds with interest payment dates spread across different dates.
(By Rajesh Cheruvu, Chief Investment Officer, Validus Wealth)