Tax Free Bonds or Debt Funds which one is better

Tax Free Bonds or Debt Funds which one is better 

 

The economic downturn is affecting even large corporate. Many of them have seen significant reduction in profits over the last financial year. This has affected their financial strength and so as their loan repayment capacity. Whenever, companies face a financial trouble, they are most likely to be downgraded. Such downgrades compound problems for companies; as they have to pay higher rate to attract money in future. In the present scenario where the short term borrowing rates are high and profitability of companies is under pressure, the list of companies facing downgrades has been increasing. 

Debt Funds investing in corporate debt are exposed to credit risk. When rating on the corporate debt is slashed; bond prices face a downward pressure as yields spike up. This is true especially in case of funds which invest in low quality debt to benefit from high yields.  Taking any call on the interest rate movement would be risky and investors shouldn't speculate. Moreover, investing in a debt fund which compromises on credit quality would be extremely risky. Only those who have a high risk appetite may consider investing in long term debt funds at this juncture provided their time horizon is relatively long. Also, only upto 15% to 20% of your debt portfolio should be in long term debt funds. Debt funds concentrating on shorter end of the yield curve may expose investors to relatively low risk.

Recently, the government has allowed about 13 Public Sector Undertakings (PSUs) to raise Rs 48,000 crore by issuing tax free bonds. The bonds would be available in 10-year, 15-year or 20-year series. Since the bonds would be tax free and be issued by PSUs; they would track the yield on 10 year G-sec bonds and coupon rates may be 0.55%-0.80% lower than the yield on 10-year G-sec benchmark bond,  given the recent jump in G-sec yields, bonds may help you lock your money at higher rate for the longer term. Moreover, their 'tax-free' nature makes them even more attractive for investors falling in 30% tax bracket.