If you’re a debt investor, the Monetary Policy Committee’s (MPC) actions last week may have left you confused. After raising its rates by 25 basis points to 6.25 per cent, MPC chose to keep markets guessing about its next step.

But the MPC’s actions may not really matter to you now. What matters is that interest rates in the bond markets have already shot up by over 150 basis points since last year. The yield on the 10-year government bond is now back at 8 per cent. Top-rated companies are borrowing 10-year money at 8.75-9 per cent Here are three fixed-income instruments that can help you piggyback into these attractive rates.

3-year FMPs

Fixed Maturity Plans (FMPs) are close-end debt schemes from mutual funds which simply buy and hold corporate bonds, usually of good quality, until maturity. They are best bought when the interest rates are ruling high.

FMPs have three advantages over alternative debt investments. One, you don’t have to worry about interest-rate swings during your holding, as the maturity of the bonds owned by an FMP are matched to its tenure. Two, FMPs carry very reasonable costs. While annual expense ratios for open-end debt funds are 1-2 per cent, FMPs charge 0.10-0.50 per cent. Three, if you buy FMPs for three-year-plus tenures (growth option), the returns are subject to long-term capital gains tax at 20 per cent, with indexation benefits. This leads to a minimal tax outgo, compared with bank/corporate FDs where returns are taxed at your slab.

Funds are not allowed to guarantee returns on their FMPs. But prevailing interest rates on three-year AAA- and AA-rated corporate bonds are at 8.5-9 per cent. This suggests pre-tax returns of 8-8.5 per cent from FMPs, after expenses.

NBFC FDs

With market interest rates shooting up, NBFCs accepting public deposits have, therefore, increased their interest rates in recent weeks.

Given that NBFCs carry higher risks, it is best to stick to the ones with AAA credit ratings, and not venture into lower-rated firms in search of better rates. However, to maximise your yield, you can consider cumulative deposits instead of regular payout options. Dewan Housing Finance Corporation, rated AAA by CARE, offers 7.90 per cent on an 18-month FD and 8.45 per cent on 36-month cumulative deposits.

A few NBFCs offer higher rates if you book FDs online. CRISIL FAAA-rated Mahindra Finance offers 8.75 per cent on Dhanvruddhi cumulative scheme for 33 months, with 0.10 per cent extra for seniors. CRISIL FAAA-rated Bajaj Finserv offers 7.85 per cent on 15-month cumulative deposits, 8.15 per cent on for 2-3 years and 8.4 per cent on three years-plus. Senior citizens are offered 0.35 per cent extra. Given that rates may be on the way up, choosing 1-2-year FDs is prudent at this juncture.

Low-duration debt funds

Given the uncertainties about rate direction, locking all your debt money into FMPs or FDs today may lead to lost opportunities if rates keep climbing. A good way to tackle this problem is to divide your fixed-income portfolio into three parts and reserve one portion for open-ended debt funds.

After SEBI’s new categorisation, Ultra-Short Duration Funds, Low Duration Funds and Money Market Funds are good bets for investors in a rising rate scenario. Ultra Short Duration Funds invest in bonds with 3-6-month duration and the other two funds buy bonds with up to one-year terms.

While choosing these funds, don’t go by past returns. Instead, choose based on for the average yield to maturity of the portfolio (8 per cent or more), a reasonable expense ratio (sub-1 per cent) and high portfolio quality (only A1, AAA or AA bonds). Aditya Birla Sun Life Floating Rate Fund, L&T Money Market Fund, HDFC Low Duration Fund (Retail), UTI Ultra Short Term Fund are a few funds that meet these criteria. Park a third of your debt money in these funds and shift into FDs or FMPs if rates trend significantly higher.

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