NPS - AIF - FD - BOND

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NPS (National Pension Scheme)

National Pension Scheme or NPS as it is popularly known, was initially launched by the Government in 2004 with the objective of changing the pension of retiring Government employees from defined benefit to defined contribution plan. In 2009, the scheme was opened for citizens of India. The broader objective of NPS is to convert India from a pension less society to a pensioned society like many developed economies.

Investment options in NPS

In NPS the contributors can decide where to invest their contributions to the National Pension Scheme. Investor can decide between two choices:-

Active Choice:

This is for informed investors who can decide where they want to invest their NPS contributions. There are four asset classes that you can choose from, depending on your risk appetite and investment needs. You can invest in multiple asset classes.

  • Asset Class E: Equity
  • Asset Class D: Corporate debt
  • Asset Class G: Government bonds
  • Asset Class A: Alternative investments like REITs, AIFs, InvITs etc.
Auto Choice:

This is for investors who cannot decide on their own, where they to invest their NPS contributions. This option is like a life-cycle fund, where the asset allocation depends on the investor's age. There are three options in auto choice:-

  • Aggressive lifecycle fund: In this equity allocation is higher than the other two options
  • Moderate lifecycle fund: In this equity allocation is higher than conservative but lower than the aggressive option
  • Conservative lifecycle fund: In this equity allocation is lower than the other two options

Types of NPS accounts

Tier I Account:

This account does not allow premature withdrawal before retirement (60 years of age). You can open a Tier I NPS account, with a deposit of Rs 500. You can claim tax deductions of up to Rs 50,000 from your taxable income under Section 80CCD by investing in Tier I account.

Tier II Account:

This account allows withdrawal prior to retirement age. You can open a Tier II NPS account, with a deposit of Rs 1,000. Tier I Account is mandatory requirement to open a Tier II Account. Tier II NPS account is a voluntary savings facility; you cannot avail Section 80CCD tax benefits in Tier II account.

Pension fund managers

Private sector employees can select among 11 pension fund managers. However, Government employees have to select from SBI Pension Fund, LIC Pension Fund and UTI Retirement Solutions only.

  • SBI Pension Funds Pvt. Ltd.
  • LIC Pension Fund Ltd.
  • UTI Retirement Solutions Ltd.
  • HDFC Pension Management Co. Ltd.
  • ICICI Prudential Pension Fund Management Co. Ltd.
  • Kotak Mahindra Pension Fund Ltd.
  • Aditya Birla Sun Life Pension Management Ltd.
  • Tata Pension Management Ltd.
  • Max Life Pension Fund Management Ltd.
  • Axis Pension Fund Management Ltd.

NPS taxation on maturity

As per NPS rules, you can withdraw up to 60% in lump sum on maturity. This withdrawal is totally tax exempt, making NPS an extremely tax efficient investment option. The remaining 40% must be in re-invested in purchasing annuities (annuity is a fixed monthly sum received by the investor). Life Insurance Corporation of India (LIC) is the default annuity service provider, but you can also choose from 13 other annuity service providers empanelled with PFRDA. The annuities received by you, will be added to your income and taxed as per your income tax rate.

AIF (Alternative Investment Funds)

Alternative Investment Funds or AIF in short, are defined as privately pooled investment funds and categorized by The Securities Exchange Board of India (SEBI) as Category I AIF, Category II AIF, and Category III AIF. It is a fund of funds (FOF) that invests in asset classes other than stocks, bonds, Government securities, fixed deposits or cash. It pools money from various HNI investors and invests them under different investment categories as specified by the SEBI for the benefit of investors.

Assets under management (AUM) under AIF can include start-ups, SME funds, infrastructure funds, private equity funds, venture capital or even hedge funds that may be trading in listed or unlisted derivatives depending on the fund type.

The minimum investment amount to invest in an AIF is Rs 1.00 Crore depending on the type of AIF. Therefore, it can be called as product meant for the HNIs.

Advantages of AIF

AIF offers diversification as the key benefit. AIFs have considerable freedom to decide where to invest unlike most other funds or mutual funds which are totally regulated and follow the fund/ scheme guidelines as mandated by SEBI.

There are various non-traditional investment options available to AIFs which generally are not available to all investors, particularly retail investors.

How AIF works?

Alternative Investment Funds or AIF raise money to form an investment fund pool that invests in non-traditional assets classes that the ordinary investors may not have access through any other products like Mutual Funds. Money can be pooled from various types of investors, example - Resident Investors, NRIs or non-resident investors or foreign investors.

Who can invest in AIF?

AIFs are mainly aimed at high net worth or HNI individuals who are ready to invest minimum Rs 1.00 Crore and take high risk. While the return potential of AIF may be very high, the risk is also very high. Therefore, this is not meant for all investors excepting those who are well versed with these kind of investing.

In summary, if you have a large amount to invest in one instrument

You have the ability to sustain the risk

You are ready to remain invested with long lock-in periods

FD (Fixed deposits)

Fixed deposits has traditionally been and still is the most popular investment option in India. As per RBI's report on household savings, 56% of household financial assets are invested in Bank FDs. Corporate Fixed Deposits are term deposits like bank FDs. They offer fixed rate of interest and principal amount on maturity. However, instead of banks, corporate FDs are offered by non banking financial companies (NBFCs). Corporate FDs are very popular among informed investors since offer higher returns compared to bank FDs.

Bank FD versus Corporate FD

Rate of return :Interest rates of corporate FDs are usually higher than interest rates of banks FDs. For example current 3 - 5 year FD interest in SBI is 6.1%, whereas Bajaj Finance is offering 7% interest rate on 3 - 4 year FD. Interest rates of corporate FDs vary from one company to another depending on the credit rating of the company. We will discuss about credit ratings later.

Tenure :The tenure for bank FDs range from 7 days to 10 years. The tenure for corporate FDs range from 12 months to maximum 4 - 6 years. If you want to invest for very long tenure e.g. 8 to 10 years, then bank FD will be the only term deposit option for you. However, for shorter tenures you may consider corporate FDs.

Lock-in period :There is no lock-in period in bank FDs. Corporate FDs may have lock-in period. Usually lock-in period for corporate FDs is 3 months; you cannot make any withdrawal prior to the completion of the lock-in period. However, not all corporate FDs may have lock-in periods.

Premature withdrawals :Premature withdrawals are allowed in both bank and corporate FDs. However, penalties may apply for premature withdrawals may be applicable for both bank and corporate FDs. If you want the flexibility of making premature withdrawals, then bank FDs will be the more favourable option for two reasons (a) no lock-in period (higher liquidity) and (b) lesser premature withdrawal penalty. While bank FDs may offer more flexibility for premature withdrawals, you should weigh this as a trade-off against higher returns offered by corporate FDs.

Taxation :Taxation of bank FDs and corporate FDs is the same. The interest paid by the FD is added to your income and taxed as per your income tax slab.

Points to consider for investing in corporate FDs

Interest rate :Different NBFCs offer different interest rates on their FDs. You should compare different FDs and make informed investment decisions. However, you should also take credit risk into consideration.

Credit risk :Credit risk refers to the NBFC's failure of meeting interest and / or principal payment obligations, exposing the investor to potential loss of income and / or capital. You should consider the credit rating of the instrument and make informed investment decisions.

Tenures :Corporate FDs may offer different interest rates for different tenures; interest rates are usually higher for longer tenures. You should decide as per investment needs.

Mode of interest pay-out :Corporate FDs offer both periodic (non cumulative) and cumulative interest pay-out. In periodic interest payout, the interest will be paid to monthly, quarterly, half yearly or yearly; the rate of interest will differ for different pay-out intervals. In cumulative interest pay-out the interest is re-invested and you get the benefits of compound interest. You should decide on cumulative or non cumulative interest depending on your investment needs.

Bonds

What are bonds?

Bonds are fixed income instruments which pay fixed rate of interest at regular intervals and the principal amount on maturity. Bonds as an asset class are very popular in the developed economies. However, the bond market in India has historically been relatively small. In more recent times, with Bank FD interest rates declining, bonds are gaining a lot of popularity among retail and HNI investors.

How do bonds work?

You can buy bonds both from the primary market (at the time when the bond is issued) or from the secondary market (stock exchanges). You need to have Demat accounts to invest in bonds in secondary market. If you buy in the primary issue, you will get the bond at face value. In the secondary market, the bonds will be priced either at premium or discount to the face value based on prevailing interest rates. The bond will make periodic interest payments to you based on the coupon rate. On maturity you will get the face value of the bond. You can also sell the bond before maturity in the secondary market at prevailing market price.

Key terms to understand in bond investing

Secured / unsecured :

Under this service, the choice as well as the timings of the investment decisions is solely lies with the Portfolio Manager.

Face Value :

The bonds are issued at face value. Face value is the amount that will be paid to you upon maturity of the bond. Coupon or interest paid by the bond is on face value. Bonds may trade at premium or discount to the face value. In other words, if you are buying the bond in secondary market (i.e. stock exchanges), then the price at which you buy will be higher or lower than the face value.

Coupon Rate :

This is the rate of interest that will be paid to you on a periodic basis. For example, if face value of a bond is Rs 1,000 and the coupon rate is 8%, then you will get Rs 80 as interest every year

Frequency of coupon payments :

This refers to the intervals at which coupon payments will be made e.g. half yearly, annual etc.

Redemption date :

This refers to the date when the bond will mature. You will get the face value of the bond, along with accrued interest (if any) on the redemption date.

Accrued Interest :

Accrued interest is the interest accrued by the seller from the last coupon payment date till the date on which the bond is sold. Since the buyer will get the full years interest on the next coupon date, the accrued interest is included in the bonds quoted price. The bonds price including the accrued interest is known as the dirty price. The clean price of the bond = Dirty price - accrued interest.

Yield to maturity :

YTM of a fixed income instrument is the return on investment (assuming interest payments are re-invested at the same rate) if you hold the instrument till its maturity. When calculating yields, both interest payments (coupons) and principal payment (face value) on maturity must be taken into consideration. Higher the YTM, higher the returns. YTM.

Duration :

Duration refers to the interest rate risk of a bond. There are two types of durations - Macaulay Duration and Modified Duration. Macaulay and Modified Durations are closely related. Macaulay duration is the weighted average term to maturity of the cash flows from a fixed income security. In simplistic terms, Macaulay Duration is the weighted average number of years an investor must maintain a position in a fixed income instrument until the present value of the fixed income instruments cash flows equals the amount paid for the instrument. Duration and maturity are related - longer the maturity, longer is the duration. It is important for you to know that duration is directly related to the interest rate sensitivity of a bond. Higher the duration, higher is the bonds sensitivity to interest changes. Modified duration is simply the percentage change in price due to the percentage change in interest rate.

Bond rating :

Bonds are rated by credit rating agencies like CRISIL and ICRA. Higher the credit rating lower is the credit risk. You should know that bo nds with lower ratings will have higher YTMs but the risk is also higher. You should make informed investment decisions.

Different types of bonds

Corporate Bonds - These are secured bonds issued by companies.

Sovereign Gold Bonds (SGBs) - These are gold bonds (backed by gold) issued by RBI on behalf of the Government.

Government Securities (G-Secs) - These are Government bonds issued by RBI on behalf of the Government of India. These bonds have sovereign guarantee.

Non convertible debentures (NCDs) - These are unsecured bonds issued by companies.

Capital Gains Bonds - You can save capital gains tax arising out sale of capital assets e.g. property etc by investing in capital gains bonds u/s 54EC.

How to invest in bonds?

You can invest in bonds through your stockbroker, just like stocks. You need to have demat and trading accounts. Contact your stockbroker if you want to know more about investing in bonds.