The word “fixed” brings to mind images of stability, security and even continuity. As the name suggests, a fixed income instrument delivers a fixed amount of income to the investors according to the structure of a particular instrument. Fixed income investments are very important as they can potentially provide investors with a stable income and help them create a diversified portfolio.
The Indian fixed income market is largely dominated by institutional investors. While few products are available to retail investors as well, they do not have a liquid secondary market, thus making participation and price discovery difficult.
The best way for retail investors to participate in the fixed income market is through debt mutual funds. However, before you go ahead and invest your money in a debt mutual fund, ensure that you understand the broad categories of fixed income instruments and their corresponding risk or return profile. We can categorize fixed income instruments into the following:
Government securities (G-secs) are issued by the Reserve Bank of India (RBI) on behalf of the central government. The government borrows money through G-secs and it is mostly to fund its deficit. Government securities have a sovereign guarantee and are considered as a risk-free instrument.
Retail investors have to open a Constituent Securities General Ledger (CSGL) account with their bank in order to participate directly in the G-sec market. However, it is advisable to invest in G-Secs through mutual funds. Fund houses offer GILT funds which comprise different government securities of different maturities and are available across the yield curve.
Inflation-indexed bonds (IIB) are a category of government securities issued by the RBI which provide inflation-protected returns. These bonds have a fixed real coupon rate ie. the rate of return moves up and down in tandem with inflation, which is applied to the inflation-adjusted principal on each interest payment date. On maturity, the higher of the face value and the inflation-adjusted principal is paid out to the investor.
These bonds are fixed income instruments issued by private companies looking to raise debt capital. They can be issued for a tenure ranging from 2 to 15 years. Most bonds are directly issued to the institutions such as mutual funds, insurance companies and provident funds through private placement. In India, corporate bonds are highly liquid. However, they do not have any kind of guarantee like government securities.
These bonds come under the purview of the Securities Exchange Board of India (SEBI) and have to be compulsorily credit rated and issued in the demat form. The interest rate offered on these bonds is largely a function of the credit rating the corporate enjoys. At the highest rating (AAA) a corporate would be able to issue the bond at a minimal spread over the G-sec yield while a lower rated corporate will have to pay a higher premium over the G-sec yield to raise funds.
From time to time, the government announces the issuance of infrastructure bonds, investment in which is eligible for deduction under section 80C of the Income Tax Act. The tenor of the bonds, rate of interest and minimum investment amount may differ across the bonds. Infrastructure bonds are compulsorily credit rated and they do not carry any government guarantee.
This instrument is well known in India. A bank fixed deposit is also called as a term or time deposit, as it is a deposit account with a bank for a fixed period of time. Fixed bank deposits generally offer higher returns than savings accounts as the bank can utilise the money in fixed deposits for a longer time period.
Fixed income instruments are generally considered safer and less volatile than equity investments. However, one should consider the tenor, return and liquidity of instrument before investing in them. Every investment carries a certain amount of risk and promises a certain rate of return. Ensure that you know the risk or return profile of your investment before investing in it.