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Returns to beat inflation

This article was posted on Jan 14, 2010 and is filed under Market News

With bank FDs offering little, the risk-averse need to check company deposits or even balanced MFs.

With inflation on the rise, risk-averse investors who prefer parking their money in bank fixed deposits will soon find themselves in a fix.

The returns on offer from banks are now quite low. Most private and public sector banks’ one-year fixed deposit rates are between 6 per cent and 6.25 per cent. For instance, State Bank of India, ICICI Bank and Canara Bank offer a one-year deposit at 6.25 per cent. HDFC Bank is offering one-year deposits at 6 per cent.

The inflation rate in November had already reached 4.78 per cent. Last month, C Rangarajan, chairman of the Prime Minister’s Economic Advisory Council, had reportedly said the rate is likely to reach 7 per cent by March. In which case, getting yourself locked into deposits that are offering 6-6.25 per cent isn’t good policy. In such a scenario, financial advisors say even risk-averse investors need to look at other avenues, that will give inflation-adjusted returns of 4-5 per cent at least.

EXTRA RETURNS
Fixed deposit rates (%)
Company 1-year 2-year 3-year
KCP Ltd 10.00 10.25 10.50
Pudumjee Pulp 9.00 9.50 10.50
Dewan Hsg 8.90 9.00 9.10
Mah & Mah 8.50 8.75
Apollo Hospital 8.00 8.25 8.75
Jindal St. & Pow 8.00 8.25 8.50
Mahindra Fin. 8.00 8.50 9.00
TN Power Fin 7.75 8.25 8.75
Excel Inds 9.50 10.00
Godrej Inds 8.00 8.50
Source: Bluechip Equity Broking

One answer could lie in company deposits and balanced funds. “A number of investors, who are unwilling to take higher risk, yet want to earn safe returns, have been consistently parking funds in fixed deposits of good companies,“ said C Saravanan, president, Bluechip India.

Well-known names such as Mahindra and Mahindra (M&M) and Jindal Steel and Power have issued fixed deposits at more attractive rates. M&M is offering an annual rate of 8.5 per cent, while Jindal Steel’s rate is 8 per cent.

If that’s not enough, you can opt for mid-caps and non-banking finance companies, that offer rates as high as 9-10 per cent. Examples of such companies are KCP (10 per cent); Pudumjee Pulp (9 per cent) and Dewan Housing (8.9 per cent).

“But before investing in company deposits, investors need to understand that as the rate of return goes up, so do the risks. When investing in such companies, a proper check on their financial health needs to be done,” said Gaurav Mashruwala, a certified financial planner.

There are several ways to judge the company’s financial health. For one, when a company seeks funds from you, instead of a bank, it is because the cost of funds would be cheaper.

For instance, if SBI’s prime lending rate is 11.75, it is much cheaper for a company if it can garner funds at 8-9 per cent from retail investors. But, if a company is willing to offer 14-15 per cent, it clearly has a problem in raising cash.

Similarly, if there is a large rate disparity between a company and a bank fixed deposit, one should avoid it. “Be wary of firms that have interest rates more than 5-6 per cent of the prevailing fixed deposit rates of large banks,” said a financial planner. In the current scenario, go for companies that offer rates below 10-10.5 per cent.

Then, one has to look at the ratings assigned to these company deposits by agencies such as Crisil, Icra and Fitch Ratings. Ratings of AAA or AA+ indicate the companies are in sound financial health.

While looking at the balance sheet could be a cumbersome process, if you are investing in a company that is offering surprisingly higher rates, take a look at its books. Parameters like profitability and the debt already on the books will give you a fair idea about its finances.

Taking all these steps is necessary because these deposits are unsecured. In other words, these deposits are not backed by any assets. If a company goes into liquidation, as has been the case many times, company deposit investors are treated as unsecured creditors The liquidator will first pay back the secured lenders, usually institutional bodies. After that, unsecured debtors are paid. Finally, equity holders will be repaid, because they are part-owners of the company.

Further, these deposits are not protected by any insurance, unlike banks. If a bank goes into liquidation, investors are assured that they will get back at least Rs 1 lakh.

Several companies have defaulted in the past. Known names who did this include Morepen Laboratories, DCM and Modern Industries, where such investors lost money.

Also, check the tax liability before investing in a company fixed deposit.

“Most of the time, FDs make little sense for people in the highest tax bracket,” said Brijesh Dalmia, director, Dalmia Advisory Services.

The average post-tax returns of short-term debt schemes or floating-rate debt funds are around 5-5.5 per cent.

For similar returns, a company deposit should give pre-tax returns of 8-8.5 per cent for people in the top tax bracket.

source: Business Standard

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