An investor looks for mainly three considerations while investing in a debt fund namely low risk, higher returns compared to traditional investments (mainly FDs) and visibility of returns. SDL Index funds can offer all three without any significant risk.
What are SDL Index funds –
State Development Loans (SDL) are target maturity index funds that aims to replicate composition of the underlying index and have specified maturity date.
Where does SDL funds invest – It invests in SDL bonds which are issued by the State Governments just like G-Securities by the Central Government. Like G-Securities, SDLs do not have any credit risk because they are also sovereign. The yields (rate of interest) of SDLs are usually slightly higher than the yields of G-Securities.
Features of SDL Index funds –
- Predictable returns and no lock-in
- Relatively low cost
- Portfolio transparency
- Low fund manager risk
- Roll down approach
- Option to transact anytime or hold till maturity.
Target maturity funds differentiates itself from normal open ended debt mutual funds by having a roll down approach with fixed maturity date making potential returns visible for an investor.
What is maturity roll down –
Bonds with longer maturity give higher yields than a bond of lower maturity. If you a buy a bond with a long maturity and hold it till maturity, then you lock-in higher yields even as the bond maturity reduces over the period. For example, suppose a 10 year bond available at 7.6% yield and while a 9 year bond available at 7.4% yield. You invest in a 10 year bond. So after 1 year, your 10 year bond will become 9 year bond but with additional 0.2% yield.
Benefits of roll down strategy with SDLs –
- No interest rate risk if held till maturity.
- No credit risk.
- Visibility of returns over long investment tenures.
- Superior returns compared to traditional investments.
- Tax efficient returns over 3 years plus investment tenure (Indexation benefit).
Target maturity funds have relatively higher tax-efficiency
|Parameters||Fixed Deposit||SDL Index Fund|
|Investment Value upon maturity||1,43,563||1,43,563|
|Applicable Tax Rate||31%||20%|
|Post Tax value||1,30,063||1,40,376|
|Post Tax Return||5.40%||7.02%|
Why invest in SDL Index fund now – As bond yields have spiked since the beginning of the year yields of SDL funds have become attractive compared to other traditional fixed income options like FDs.
If you are looking for a fixed income investment for next 4-5 years then SDL Index fund is a suitable option because there is negligible credit risk as fund invests in SDL securities. As it is fixed maturity index fund there will be better visibility and reasonable predictability of returns and with indexation benefit it will have higher post tax returns compared to Fixed deposit.
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