Three Simple inveSTmenT

Three Simple

inveSTmenT opTionS for ShorTerm

november 2013

an investor education andawareness initiative by hdfc mutual fund 1

short term investingshort term investingshort term investing

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Outlook Money does not accept responsibility for any investment decision taken by readers on the basis of information provided herein. The objective is to keep readers

better informed and help them decide for themselves.

asst art director Anil PAnwAr

Three simple investment options ............................. 2Matching funds to needs ......................................... 6Liquid funds ............................................................ 8Fixed maturity plans ............................................... 18Capital protection oriented funds .......................... 21

contents

2


Investing in mutual funds can be a

profitable experience if one is able to do

so in the right manner. The universe of

mutual funds can be slotted into equity,

there are a class of funds that are tailored to provide safe investment options to retail investors

short term investingshort term investingshort term investingshort term investing

4

debt and hybrid schemes (which have a mix of

both debt and equity). A lot is documented about

equity funds, but very little is highlighted about debt

funds. The asset management industry handles more

money under debt schemes than equity. For long,

the range of debt funds were targeted at corporate

and HNIs, with very little choice for retail investors.

However, in recent years, a range of debt funds have

emerged that are extremely useful for retail inves-

tors to create both income streams as well as have

growth possibility.

The penchant for Indians to save is reflected

in the high sums of money that sit in our savings

bank accounts. Take for instance the total bank de-

posits in scheduled commercial banks which was

Rs. 706,01,822 million as on June 30, 2013 (Source:

RBI). The reason for such undying faith in bank savings

is the safety and liquidity that the instrument offers.

However, most savers and depositors do not realise

or evaluate the tax inefficiency of such deposits or



when adjusted to inflAtion, reAl return in bank fds, more often than not, tends to be negAtive

the low interest rates that they earn. When adjusted

to inflation, the real return more often than not tends

to be negative.

6

mAtching funds to needsOne of the biggest problems with investors is that

they try fitting the fund they have invested to their

needs. By reversing the process, one should be able

to get a better result viz. first identifying the need and

then selecting a fund. So, if you are looking at an al-

ternate to surplus money lying idle in savings or post

office account; go for a liquid fund. If you are seek-

ing safety of capital with growth possibility, a capital

protection-oriented fund is a better option and if you

are looking for an alternate to term deposits of a bank

or a post office for a predictable time horizon of say

if you seek sAfety of capital with growth, a capital protection-oriented fund is a better oPtion



capital protection funds instead of bank and post office fixed deposits of 3 years or more

mAtchmAking liquid funds

instead of savings bank account and

post office

fmps instead of bank and post office fixed deposits up to 3 years

one year, a Fixed Maturity Plan (FMP) with reason-

able return and low risk is the right choice.

But, a good start is made when you identify a class

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of funds that would meet your financial needs and

invest in them. Having identified funds that address

specific savings and investment need, the next step

is to get a better understanding of how the alternates

fare and then start investing in them.

liquid fundsThe idea of keeping emergency fund somewhere

other than a savings account may not strike many,

but it is an option worth exploring. No doubt, li-

quidity and safety are more important factors for

emergency funds, but there is no harm in optimising

returns, without sacrificing on safety and liquidity.

It is in this context that liquid funds come into play

which combines safety and liquidity, along with tax

efficient returns when compared to savings account

with bank or post office. However, NAVs of liquid

funds are prone to capital erosion over shorter period

especially when there is heavy redemption pressure

or due to market fluctuations/RBI measures.



liquidity and sAfety are more important factors for emergency funds

These funds have the primary objective to invest

in money market and debt instruments with maturi-

ties of upto 91 days, generating optimal returns while

10

how liquid funds stAck uPsavings account liquid funds

liquidity high high

Annualised returns (%) 4 and above 7-8*Lock-in None 1-day

Principal guaranteed

Up to Rs 1 lakh by the government as long as it is insured by the DICGC

No guarantee

Chequebook facility Available Not Available

Income Tax As per tax slabs

Taxed at concessional rate as per table below

resident investors mutual fund

Dividend Income Nil

Dividend Distribution Tax (DDT) Individual / HUF 28.325%** Others 33.99%**

capital gains

Long Term

11.33%** without indexation or 22.66%** with indexation

Nil

Short Term

Income tax rate applicable to the unit holders as per their income slabs.

Nil

* Source: Mutualfundsindia.com Returns as on 22 October, 2013**Including applicable surcharge, education cess and secondary and higher education cess



maintaining safety and high liquidity. Liquid funds

primarily invest in instruments such as certificates of

deposits (CDs), commercial papers (CPs) and govern-

ment treasury bills. Such a portfolio helps liquid funds

provide high liquidity to investors. Accordingly, for

redemption requests submitted on any business day,

the amount is made available on next business day.

Why liquid funds? These funds provide good liquid-

ity and the prevailing yield in the market. Due to

investment in instruments with short maturities, the

the objective is to invest in money market and debt instruments, generate optimal returns and maintain sAfety and liquidity

12

liquid funds have lower interest rate risk and provide stAble returns because they invest in instruments with short mAturities



portfolios of liquid funds have lower interest rate

risk and provide stable returns to its investors. While

liquidity is one factor of these funds, for long their

safety has made them the preferred parking option by

both HNIs and Corporates.

Most of these schemes have no lock-in period and

offer redemption proceeds within 24 hours and one

can park from as less as Rs. 10,000 in these funds.

Hence, liquid funds offer a good alternative to sav-

ings bank deposits.

The other advantage of liquid funds is that their

NAVs are computed on all calendar days (even on

weekends and holidays). Therefore your money con-

tinues to earn even on weekends and holidays.

What to look for when investing in them? Look for

the credit quality of the portfolio before investing and

the type of instruments in which it invests such as

commercial papers (CPs), Collateralised Debt Obliga-

tion (CDO) and certificate of deposits (CDs). Higher

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the investment in highest rated securities, lower the

risk and vice-versa.

Tax advantage. Short-term capital gains tax applies

on liquid funds that are held for less than a year at

the income tax slab that one falls in. However, there

is tax efficient strategy that you can adopt. Dividends

from liquid funds are tax-free in the hands of the

investors, which makes them more attractive than

bank fixed deposits. Consider opting for dividend

reinvestment when investing in a liquid fund because

dividends paid will be reinvested as units and will

be considered as fresh investments. This way the

capital gain will be very low. In case you do plan to

hold the investment in liquid fund for over a year; opt

dividends from liquid funds are tAx-free in the hands of the investors



for the growth option to benefit from the indexation

benefits. For those in lower income slabs, choosing

growth option my be more beneficial.

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fixed mAturity PlAnsBank deposits guarantee a fixed return for a fixed ten-

ure, however, there is a type of scheme—fixed ma-

turity plan (FMP), which is a tax-efficient alternative

to bank fixed deposits with marginal risk compared

to bank deposits. FMPs are closed-end funds, which

means you can invest in them only when they are

launched and is automatically redeemed when the

fixed term is over.

Although returns on FMPs are not predictable, yet,

for investors who want to invest money for short period,

these are a perfect fit. These funds invest in instruments

for investors who want to invest money for a short period of time, fmPs are a perfect fit



that have the same or lower maturity period as that of

the scheme. This makes FMPs least volatile. For instance,

in case of a 1-year FMP, the average maturity period of

the portfolio would be around 360-365 days but not

more than that. Therefore, irrespective of the variation

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in prevailing interest rates or the impact of the same on

the market value of the bonds, the actual returns do not

get affected. Opt for an FMP, which has tenure similar to

your investment goal. FMPs are listed on exchanges to

provide liquidity to investors during the tenure.

comPArison of fixed mAturity PlAn with bAnk fixed dePosit

Particulars FMP FD

Amount Invested (Rs) 10,000 10,000

Assumed Rate of Return (For illustration purpose only) (%) 10 10

Projected Maturity Value (Rs) 10,493 10,493

Gross Dividend/Interest (Rs) 493 493

Dividend Distribution Tax Rate (%) 22.07 30.90

Tax (Rs) 109 152

Net Dividend / Interest (Rs) 384 341

Post Tax Value (Rs) 10,384 10,341

Post Tax Returns 7.79% 6.91%

Assuming income tax at the highest bracket (up to 1 crore income) of 30%.


short term investingshort term investingshort term investingshort term investingshort term investing

fmP suitAbility

Investors looking at

stable returns over short to

medium- term

Investors who are not pleased

with returns from traditional fixed income avenues

like bank deposits, bonds etc.

Investors with a conservative and risk averse

profileInvestors who want to invest

money for a fixed tenure to meet certain financial

goals in the future

Retired persons, instead of making

random withdrawals from their savings, can invest to have a flexible and regular

income

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Why FMPs? FMPs are less risky

than equity schemes (though more

riskier as compared to fixed deposit)

due to their investment in debt and

money market instruments. They

also offer relatively better returns,

especially post-tax returns in an

FMP are better than a fixed deposit.

As these investments are held till

maturity, there is no exposure to interest rate risk,

which also keeps them off interest rate volatility.

The Tax Advantage Where FMPs score over fixed

deposits is the way they are taxed. These are tax effi-

cient both in the short-term and long-term. Moreover,

with indexation, one can lower capital gains and thus

lower one’s tax liability. If one uses double indexation,

it allows an investor to take advantage of indexing his

investment to inflation for 2 years while remaining

invested for a period of slightly more than 1 year.



cAPitAl Protection oriented fundsInvestors looking for safety and capital protection with

growth possibility over medium term should consider

capital-protection-oriented funds to invest money in-

stead of bank fixed deposits (FDs). The main objective

of such funds: capital protection with growth potential.

These do not guarantee capital protection, or returns.

The orientation towards protection of capital originates

from the structure of the Portfolio of the Scheme and

not from any Bank guarantee, Insurance Cover etc.

Typically such funds invest in fixed-income instru-

ments such as bonds, Treasury bills and certificates

of deposits (CDs) with a marginal exposure to equity.

Capital protection oriented funds are close-ended and

have maturity period of generally three to five years,

which are far easy to understand, especially for those

who are used to saving in fixed deposits.

Why Capital Protection oriented funds? These funds

adhere to SEBI guidelines and in no way do they

22

guarantee capital. The scheme invests ~ 80-85% in

debt securities and balance in equities. The protec-

tion of capital comes from typical structuring of the

portfolio wherein the debt component grows to the

principal amount, net of scheme expenses, over the

tenure of the scheme, say 3 years. This would leave

about 15-20 percent of the portfolio free for the eq-

uity component. These funds are required to have the

highest credit rating which is periodically reviewed by

the rating agency with the view that the debt compo-

nent should grow to the initial amount invested (i.e.

the principal amount) over the tenor of the scheme.

The equity edge: For the equity allocations, two vari-

ants are followed by the fund: either the scheme may

capital protection oriented funds adhere to sebi guidelines, but don’t guArAntee capital



invest directly in equity and liquidate the portfolio

before the maturity or the scheme invests in index

options wherein the fund manager purchases long

dated call index options and the equity allocation is

used to pay the premium on the index option con-

tract. From a risk and return perspective the direct

equity strategy is more conservative than an index

24

cAPitAl Protection suitAbility

Suitable for people

who require cash flows as the time of maturity is known when making the

investment.

cAPPsuit

Currently, these funds are

better placed then they were in the past on the

debt allocation. Post recent RBI measures to control

rupee volatility, the yields have moved up across maturities which makes

it a more suitable option now.

maturities which makes

The returns from

these funds over its tenure are a function of prevailing yields in

debt market and returns from equity allocation

which has slight correlation to equity

valuations.

options strategy, however, both strategies have their

pros and cons and direct equity strategy is relatively

low risk variant when compared to index option

strategy. These fund are listed on stock exchanges to

provide liquidity to investors during their tenure.

disclaimerThe information given herein is as per the prevailing tax laws. Investors should be aware that the fiscal rules/ tax laws may change and there can be no guarantee that the current tax

position may continue indefinitely. In view of the individual nature of tax consequences, please consult your professional tax advisor.

As part of its Investor Education and Awareness Initiative, HDFC Mutual Fund has sponsored this booklet. The contents of this

booklet, views, opinions and recommendations are of the publication and do not necessarily state or reflect views of HDFC

Mutual Fund. HDFC Mutual Fund does not accept any liability arising out of the use of this information.

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED

DOCUMENTS CAREFULLY.

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Three Simple inveSTmenT