How should you expose yourself to government development loans


One investment avenue that has opened up to investors in recent years are SDLs or State Development Loans. These are bonds issued by state governments to raise funds. While SDLs were a part of mutual fund portfolios even in the past, investors only had the chance to gain focused exposure to them with the launch of Target Maturity Funds (TMFs). Now, through RBI’s Retail Direct program, investors can also purchase SDLs directly at auctions conducted by the central bank on a schedule.

SDLs can offer higher yields than GOI bonds or G-Secs, although they can be less liquid, making an exit before maturity all the more difficult. Concerns over the security of SDLs were however allayed after the RBI Governor, at a post-monetary policy press conference in June 2019, said that SDLs were backed by an implicit sovereign guarantee and could not therefore not be considered risky.

Choices offered

The RBI holds periodic SDL auctions, as it does for G-secs where institutional investors can place competitive bids. Retail investors can also participate in these auctions through a Gilt Retail Direct (RDG) account with the RBI. Five percent of the loan amount is reserved for retail investors through non-competitive tenders. Retail investors can bid for the amount of the investment and are allocated securities at the weighted average rate obtained in the tender.

Alternatively, one can gain exposure to SDLs through target maturity funds (TMFs) – debt funds that passively track an index with a set maturity – which have been launched in the last year. And there are more to come with many TMFs currently awaiting SEBI approval.

While investing directly in SDLs is an attractive proposition, the TMF route has many advantages.

Here are the main differentiators between the two:

Most existing TMFs invest in a combination of SDLs, G-secs and corporate bonds and not in SDLs alone. There is, however, Nippon India ETF Nifty SDL – 2026 Maturity, an SDL-only ETF, which invests in the constituents of the Nifty SDL Apr 2026 Top 20 Equal Weight Index. Note that unlike a TMF which invests in SDLs from multiple state governments, RBI auctions give you the flexibility to invest in specific state government SDLs, if you wish.

long and short

Today, all existing TMFs with some SDL exposure have a maturity of 4-5 years. These TMFs invest largely in SDLs listed on the secondary market and whose maturity corresponds overall to the maturity of the index they follow. On the other hand, if we go by the last RBI primary market auction held on January 18, most of the SDLs on sale had a maturity of 10 years or more and offered yields of 7.2 to 7, 3%. While this sounds attractive compared to the 6% (approximately) offered by existing TMFs, these SDLs have much longer hold times.

With interest rates set to rise, it’s best not to tie up your money in such long-term securities, especially since a lack of adequate trading volumes can make it difficult to exit your investment prematurely. Also, even if you can exit before maturity, you face the risk of capital loss – falling prices of existing bonds as interest rates rise. The longer the maturity of a bond, the higher this risk.

Ease of exit

TMFs offer a degree of return predictability for those who stay invested until the fund matures. Although exiting a TMF prematurely may expose you to potential capital loss, you can do so, if necessary, with ease. This is at least the case with the target maturity index funds where you interact directly with the AMC. In the case of target-maturity ETFs, which trade on an exchange like stocks, this depends on the availability of adequate trading volumes.

Similarly, while buying SDLs in the primary auctions may be easy, despite having access to the secondary market through the “NDS-OM Secondary Market” platform provided by the RBI RDG account, selling them may not be possible. easy.

Expenses and taxation

Investing in SDLs through the RBI RDG account does not incur any costs, neither for opening the account nor for transactions through it. To invest in TMFs, on the other hand, you have to bear the expense ratio. Most TMFs that hold SDLs in their wallet charge 0.15% as an expense ratio.

When it comes to taxation, TMFs clearly score higher than direct investment in SDLs, especially for those in the higher tax brackets. Your interest income from SDLs is taxed at the applicable rate of your tax slab. In contrast, capital gains on the sale of TMFs (which are debt funds) held for more than 3 years are taxed at a fixed rate of 20% with the benefit of indexation. In other words, you can adjust the initial value of the investment for inflation, thereby reducing your capital gains for tax purposes. This can significantly reduce your tax liability.

That aside, TMFs come with lower minimum investment requirements such as ₹500 to ₹5,000 and in multiples of ₹1. Direct investment in SDLs can only be done for a minimum of ₹10,000 and in multiples.

High security

SDLs are backed by an implicit sovereign guarantee and therefore cannot be considered risky

Published on

January 22, 2022


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