Select Fixed Income Instruments Judiciously

The most popular of fixed income avenues in India are:

1. Fixed deposits with banks and post offices
2. Fixed deposits with companies
3. Public sector bonds
4. Income oriented and growth oriented debt schemes
5. Non-convertible debentures of private sector
6. Convertible debentures
7. National Savings Certificates
8. Provident fund contributions
9. Kisan Vikas Patras

The relative attractiveness of various fixed income avenues depends mainly on two factors: (a) need for tax shelter; and (b) preference for current income versus capital appreciation. The following matrix will broadly guide you in selecting fixed income avenues based on these two considerations.

While the matrix provides broad guidelines, here are some specific suggestions:

Preferred Form of Return

Tax Shelter sought:
1. Post office savings bank account
2. Tax free bonds


1. Non convertible debentures
2. Fixed deposits with companies

Capital appreciation:


1. Provident fund schemes
2. Growth oriented debt schemes


1. Kisan Vikas Patras
2. Convertible debentures

Since the investor has the option of retaining the convertible debenture as a straight debt instrument, it is viewed here as a fixed income instrument.

If you are seeking to reduce your tax liability in the long run, deposit as liberally as you can in a recognized provident fund scheme and/or public provident fund scheme. Investment in provident fund scheme offer several advantages: (a) initial tax advantage; (b) continuing tax advantage; (c) facility for partial withdrawals; (d) satisfactory rate of return; and (e) immunity from attachment by a court decree. Given these advantage, it is boon to the bulk of the investors. Hardly any other form of investment offers such attraction. Hence, it should be accorded a very high priority in your scheme of investments.

Give preference to income oriented debt schemes and tax free bonds if you are looking for a tax sheltered current income. They offer attractive post tax rates of return compared to other fixed income avenues.

Invest in good convertible debentures. Due to some peculiar reasons, convertible debentures, in, general sell for a price lower than the market value of the underlying equity. Yet, till the conversion takes place, the interest income on them is higher than the dividend income provided by the underlying equity. Given this anomaly of the Indian stock market, it makes sense to buy convertible debentures.

Consider investment in non-convertible debentures, Kisan Vikas Patras, and corporate fixed deposits schemes under two broad circumstances.
(a) when your taxable income is less than Rs 100,000; and
(b) when you have exhausted the limits for various tax sheltered investments

While evaluating non-convertible debentures look at the following factors:

(a)Yield to maturity
(b) Credit rating
(c) Maturity period
(d) Buy-back facility

Look at the following factors making a fixed deposit with a company.

(a) Reserves and surplus in relation to paid up share capital
(b) Track record of earnings and dividends
(c) Reputation of management
(d) Credit rating.

Focus on Fundamentals, but keep an Eye on Technicals:

In choosing equity shares go largely by fundamentals but do not lose sight of technicals. This broad guideline may be implemented in terms of three sub-guidelines: (a) establish value anchors, (b) assess market psychology, and (c) combine fundamental and technical analysis.

Establish Value Anchors: The intrinsic value of a share is determined by three fundamental factors: earnings (and dividend) level, growth prospects, and risk exposure.

With the help of the analysis discussed earlier, you can get a handle over these factors and estimate the intrinsic value by employing the dividend capitalization model or the earnings capitalization approach. However, as valuation is essentially an uncertain and imprecise exercise, it would be naïve to put great faith in a single point intrinsic value estimate. Practical wisdom calls fir defining an intrinsic value range around the single point estimate. For example, if you arrive at an intrinsic value estimate of, say, Rs 50 for some share, it may be more sensible to talk of an intrinsic value range of say, Rs 45 to Rs 55. When you define a range like this, you are essentially saying: While my single point value estimate is Rs 50, I am aware that there may be bias and errors in my estimate. To take care of these, it makes greater sense to talk of an intrinsic value range of Rs 45 to Rs 55. Using this range as the value anchor, your decision rules may be as follows:

Market price Decision

Less than Rs 45 Buy
Between Rs 45 and Rs 55 Hold
More than Rs 55 Sell

In establishing the value anchor, you may have to use a price earnings ratio. Remember that it is theoretically equal to:

Payout ratio / Discount rate – Growth rate

For example, if you expect the payout ratio to be 0.5 the discount rate to be 0.16 and the growth rate to be 0.10 you establish the price earnings ratio as follows:

0.5 / 0.16 – 0.10 = 8.33