Power Finance Corporation - Tax Free Bonds - October 2013

Power Finance Corporation (PFC), a PSU Navaratna company has come out with a tax free NCD Issue for Rs 750 crores in October 13 (with a green shoe option up to Rs 3876 crores). The PFC Issue has attractive yields over tenures of 10 years, 15 years and 20 years and is very relevant for those in the 20% and 30% tax brackets.  NRIs can also apply for these bonds on a repatriation as well as non-repatriation basis.

Credit Rating:

These bonds have been rated “AAA” by all the three credit rating agencies which is the highest rating.  The total loan assets of PFC were Rs 160,000 crores with a Gross NPA of 0.71% and a comfortable capital adequacy ratio of 17.98% as of 31^st March 2013.

Issue Opening Date	14th Oct 2013
Issue closes on	11th Nov 2013
Credit Rating	AAA by CRISIL,  CARE and ICRA
Face Value	Rs 1000
Minimum Application	Rs 5000 (minimum of 5 bonds)
Coupon - Category IV (Retail – Up to Rs 10 lakhs)	10 year - 8.43% 15 year - 8.79% 20 year - 8.92%

 

Advantages of this Tax free bond Issue

• The post tax return of 8.79% (15 year duration) and 8.92% (20 year duration) is much higher than normal bank fixed deposits (between 6 to 7% at current FD deposits for those in the 30% tax bracket)
• There are no upper limits (unlike PPF accounts where there is a limit of Rs 1 lakh investment per year) on the total investments.
• It is ideal for investors looking to lock in returns for a large amount of money over the long term
• No wealth tax will be levied on the investments in these bonds
• The  bonds will be listed and traded on the BSE (but the liquidity of these bonds remains to be seen)
• High degree of safety (AAA rating) for the bond which is also secured by a charge on the book debts of the company

   Investment Recommendation:

We recommend investing in this tax free bonds from PFC and you may either choose the 15 year or 20 year option depending on your time horizon.  It is an excellent product to add to your debt portfolio towards long term goals like retirement planning or children education.   

The important point to be noted here is that the annual interest payouts should be deployed in other avenues to grow the corpus rather than leaving the money to be spent for living expenses. It is better to move the yearly interest to PPF or debt mutual funds or equity mutual funds as per the investor’s risk appetite.

Chennai real estate prices show a correction in Residex scores

Real Estate prices across Chennai market has seen a correction across the board according to the Residex scores released recently.  This is mirroring the trend across India.  The prices which has fallen the steepest in Chennai are Myalapore and Velachery.  

With the recent RBI action of stopping the 80:20 schemes, the builders would be under higher stress for funding.   They have been valiantly holding on to the price levels but something to give. In the earlier instances, the buyers had given in but this time my hunch is that the sellers would give it in.  They would no longer be able to borrow to support the prices artificially. If few desperate sellers start the distress sale, all others would fall in line.  

As far the real estate prices are concerned, I believe that further price drops are possible in the suburban areas.  Already the builders are open for negotiations on price and instead of being selective; they would announce price cuts across the board.  The number of unsold flats in the suburbs is a good indication of the impending possible price correction.  

The spate of new launches has gone down and the classifieds section in newspapers has more advertisements for sale.  I recently read that during the 90’s real estate meltdown, the prices corrected by more than 40% over the period of 1996 to 2000 in Mumbai. Is it fair to expect the same amount of correction across the board? May be, not.   The price correction would be location specific.  

I think it is becoming buyers market after a long time. 

REC Tax Free Bonds - Sept 2013 - Invest

One of the PSU Navaratna companies, REC has come out with a tax free bond issue for collecting funds of Rs3500 crores (including the green shoe option).  This is the first issue out of the 12 odd issues expected from various PSUs over the next 6 months or so.  The tax free bonds are available in tenures of 10 years, 15 years and 20 years.  NRIs can also apply for these bonds with repatriation and non-repatriation benefits.

Credit Rating:

These bonds have been rated “AAA” by all the credit rating agencies meaning that the principal and interest would be serviced on time by the borrower.  This is the highest of the credit ratings available for any bond issue. 

Interest Rates:

Coupon - Category IV (Retail)

10 year - 8.26% 15 year - 8.71% 20 year - 8.62%

The above rates are for retail investors who subscribe less than Rs10 lakhs.  For all other category of investors, it is 25 basis points less than the retail interest rates.  Considering the recent spike in Government Bond yields, the investors are lucky to get higher tax free interest rates.  

Interest would be paid out on 01 Dec every year during the tenure of the bond.

The rates on tax free bonds from PSUs are determined by the Finance Ministry based on the G-Sec yields prevailing two weeks before the issue date.  The Finance Ministry has allowed the PSUs to offer yields up to 55 bps less than the prevailing G-Sec rates to ensure that these issues don't fail as few of the previous tax free bond issues last year and early this year.  

Taxation:

As these are tax free bonds, there is no tax payable by any investor.  These tax free bonds are also a very useful tool to transfer wealth to spouse or others without attracting the clubbing provisions under Income Tax act.  As the income from REC Tax free bonds are exempt from tax, there is no clubbing provision applicable for investors.  

Investment Recommendation:

We recommend investing in this tax free bonds from REC and you may either choose the 10 year or 15 year option depending on your time horizon.  It is an excellent product to add to your debt portfolio towards long term goals like retirement planning or children education.   

Investors across all tax slabs can invest, though investors in the lower tax may be better off investing in Bank FDs at current rates.  

This is suitable for all types of investors as there is no volatility in returns compared to debt mutual funds.  

The issue closes on 23rd September.  If you are planning to invest, it is better to do it earlier as the retail portion has been already seen subscriptions of above 50% in 2 days. 

What are the points you have to note before investing in this bond? 

Not a cumulative product:  The important point to be noted here is that these bonds have annual interest pay-outs.  That is, REC would pay annual interest and you have to find ways and means to deploy the interest to further grow it.  If you don't have PPF account, it would be a good option to open a PPF account and move the annual interest directly to the PPF account.  

For somebody who is willing to take some risk, they can invest the annual interest in good quality debt or equity mutual funds.  

As there is a flood of Tax free bonds which are expected over the next 6 months, the investors may get more options to invest in tax free bonds.  It is also possible, that the newer issues from other PSUs may have higher interest rates.  But it is very difficult to predict how the interest rates would move for the forthcoming tax free bonds in 2013. 

Investing in Turbulent Times

Re-visiting the key events of last 2 months:

·         Rising Current Account Deficit in India thanks to high crude and gold imports accompanied by falling Indian exports

·         Possible tapering of Quantitative Easing (QE) by US Federal Reserve and as a result of that flight of capital from emerging markets towards US Treasuries

·         Announcement of quantitative easing by Bank of Japan on the same lines of US Federal Reserve to promote growth in the Japanese economy

·         Drastic depreciation of Indian Rupee by more than 12% due to concerns on the CAD front and reduced FII inflows. On Tuesday it hit the all time low of Rs61.79 against USD

·         Measures announced by Reserve Bank of India to strengthen Indian Rupee which indirectly increased the short term interest rates in the economy

How the Markets reacted in India:

·         The Indian equity markets have been on a continuous downward spiral over the last 2 months.  In the last week of July, the Indian markets closed in the red for 8 continuous trading sessions

·         The Nifty has fallen from 6000 levels to 5500 over the last 1 month or so.  Banking stocks bore the brunt due to slowing economy and rising NPAs.  Bank Nifty has fallen more than 20% in the last 2 months and trading below 10000 levels today

·         Debt markets had also been very volatile thanks to ad-hoc and indirect interest rate hike by RBI 

·         Indian Government Bond yields have risen from 7.30% levels in June 2013 to 8.55% levels in August 2013.   The 130 bps rise in bond yields drove the prices down across the board resulting in mark to market losses for debt fund investors

Now the important question to be answered is how we go about investing in these turbulent times.  The questions in our mind are should we stop investing? Would the market ever recover?  Will I recover my investments? 

Definitely it is lot more challenging to invest in these difficult market conditions.  But always remember the famous words of Warren Buffet, “Be greedy when others are fearful”.  In these dark clouds, there is definitely a silver lining for investors.  The opportunities are available across the board in fixed income debt and equity investments.  Let’s look at fixed income investments first.

Fixed Income investments:

The interest rates have risen now and there is a sense of understanding in the Government and RBI that monetary policy actions like interest rate hikes alone would not help strengthen a currency beyond a point.  For a currency to strengthen, the fundamentals have to be sound. 

The short term rates have zoomed beyond 10% and any further rate interest rate hikes may be very measured in the near term. 

Therefore, these elevated interest rates in the economy, which in our opinion would be only for a shorter term of say 1-6 months, provides a good opportunity to lock in to fixed income investments like Bank Fixed Deposits, Fixed Maturity Plans (FMPs) and corporate deposits.  For people in the higher tax brackets, FMPs would be an ideal choice of investment considering the tax benefits it provides compared to fixed deposits. Be careful though in choosing the right FMP as the credit quality is very important.

For aggressive investors who are willing to take some risks, they make take some staggered exposure in debt mutual fund over the next 6 months. 

Equity Investments:

Broadly speaking, the markets have corrected by 7% over the last 2 months or so.  But if you we dig deeper in to the market fall, you will find that the index levels were maintained due to few select stocks holding ground.  Stocks like Hindustan Unilever, ITC, Reliance, TCS and Infosys have held on well in this downward movement and thereby not letting the index levels fall below 5650 levels. 

But if you exclude them and see rest of the market, you will understand that the corrections have been sharp. 

It is possibly a right time for somebody to take fresh exposure to Indian equities as an asset class.  For investors who have already invested in the market, we suggest to hold on to their investments and when the tide turns, you will make handsome returns.  If you can afford, you may please add up to your positions in a staggered manner over the next 6 months. 

SIPs in established and well run mutual funds are our preferred choice of investment in respect of equities. 

Please write back to us if you would like to know more about any of the investment opportunities discussed above.  We remain at your service.  Happy Investing! 

Markets this week: Volatile Bond market, Big FDI reforms and Range-bound stock market:

The week began on a brisk note with stock markets showing gains but the Indian Rupee was struggling below Rs60 to the dollar.  The situation was getting out of control for the RBI and the Government from inflation management and CAD perspective.  Left with little room for error, on Monday evening around 8 pm, RBI introduced a slew of measures with an eye of propping up INR.  They increased the MSF rate to 10.25 and restricted the bank borrowings to Rs75,000 crores from RBI.  The reason attributed was that liquidity in Indian markets is driving the Rupee down.  

Thanks to the RBI’s sudden and drastic monetary tightening, the yields on G-Secs and Corporate bonds rose by more than 0.5% in the last 3 days.  This resulted in big drop in NAVs of debt mutual funds, particularly funds with long duration maturities.  

The Rupee today was trading at Rs59.70 to the Dollar after having gained a mere 50p due to the various measures of RBI.  

I think RBI was barking at the wrong tree.  Rupee depreciation is driven not only by liquidity in the system but also due to genuine dollar demand by importers, particularly for oil.  Unless we as a nation reduce the oil imports and the resultant dollar outflows, we are forced to depend on FII investment flows to meet our Current Account Deficit.  Not a very healthy situation to be in. 

Gold – Are you a bull or a bear?

Gold has corrected big time over the last 2 trading days and giving shivers to gold bulls.  Is it the end of the bull run in Gold is the common question in the minds of investors?  

What should investors do now? It depends on the nature of the gold holdings one has.  If it is held for consumption purposes, then there is nothing to panic.  Continue to enjoy wearing that necklace or bangles and it is possible that you can now wear it at least now without the fear of being robbed, due to sliding gold prices!! 

Jokes apart, but, if you have been buying gold as an investment asset and that do overdoing it, then you seem to have a problem.   The stress is again on overdoing it.  If you have balanced portfolio allocation, then this price fall should not make you lose sleep. 

If you are somebody who has no exposure to gold at all, then you may use this price correction to start buying like me.  Remember to use the Systematic Investment Plan route in buying gold now, if at all, you are buying. 

This price correction like corrections in other markets, reinforces, the key fact that asset allocation is the most important thing in portfolio construction. 

If you have limited your gold exposure to, say, a maximum of 10-15% of your portfolio size, then this 10% correction doesn’t make any big impact.  Your portfolio value would have gone down by say a maximum of 1.5%.  This 1.5% erosion in portfolio value is not a show stopper in anybody’s portfolio. 

But at the same time, if somebody has say 60% of their investment in gold, then this 10% correction in prices should have dented the portfolio to an extent of 6% or so.  Some may lose sleep on this.  

So, now the obvious question is what he or she should do now? At this moment, there is no clear answer honestly.  The price of gold may recover from here or can fall further accentuated by covering of long positions by gold speculators across the globe.  If you feel you have overweight on Gold currently in your investment portfolio, then you may want to use the rallies to sell in smaller lots.  Just like you are planning to sell,  most of the other gold investors would also be planning as well!! So, to me, this price correction may continue for some more time. 

Let truth be told.  Nobody can predict it with certainty tomorrow’s price!

You should take this as a reminder to start balancing your portfolio across asset classes.  

A well defined asset allocation is the key to building a solid portfolio in the long run.  

Happy Investing!