InvestorQ : How do the floating rate bonds of the government rank versus debt funds as an investment option?
Mary Joseph made post

How do the floating rate bonds of the government rank versus debt funds as an investment option?

Answer
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sara Kunju answered.
3 months ago


Floating rate bonds are issued by the government of India and hence ranks high on the safety metrics. Floating rate bonds are fine as long as rates do not fall too steeply. The pre-tax yields are good although not too attractive in post-tax terms. For example, if rates correct by another 200 bps, then you would be stuck in low yield bonds.

You need to be aware of some practical disadvantages of these floating rate bonds. These bonds will not be traded on any secondary stock exchange so there is no liquidity and there is also no exit route for investors. You cannot leverage these floating rate bonds as they are not accepted as collateral for loans and that restrains monetization.

Having looked at the limitations of these floating rate bonds, how do they compare with debt funds? Clearly, these bonds entail a 7-year lock in compared to free entry and exit in debt funds. Even in terms of returns in pre-tax terms the debt funds are on an average at par or better than floating rate bonds giving around 8% yields.

But the real catch is in pot tax returns. Debt funds structured as SWPs can be more tax efficient compared to floating rate bonds, which are subject to tax at the peak rates. Also, debt funds are more likely to benefit from falling interest rates (a more likely scenario in Indian bond markets). These should make one prefer debt funds over floating rate bonds.