Infra bonds – Is the advertised yield really true?

Many people are aghast by the yield on Infra Bonds advertise by the companies and do not believe the same to be true.  In line with the basic principle of this blog - to make investing simpler - this article will try to clarify various doubts which many of my readers and investors have about these Infra Bonds.  Readers may also like to visit my earlier post on Infra Bonds.  

Reference here is made to L&T Infra Bonds since it is the only Infra bond which is open for subscription right now.  In no way it encourages or discourages any one to invest in the said bond.  Investment has to be made in line with the risk profile and investment objectives of an individual.

1. Is the tax-adjusted yield of 17.20% advertised really true (for Series III L&T Infra Bonds having 7.50% interest rate)?

This yield is based on certain assumptions:

a. You opt for the buyback option at the end of the 5 years.

b. You are able to take the benefit under Section 80 CCF of the Income Tax Act.

c.  You are in 30.90% tax bracket.  In case you are in lower tax bracket, the tax-adjusted yield will definitely be lower (further cover in detail below).

d.  It further assumes that you are investing the annual interest earned at the rate of 17.20% p.a.  Well I know this can never be achieved.  But this is the assumption behind the calculation.  In case, you assume that you are able to invest the annual interest earned at the rate of say 7.50%, then the tax-adjusted yield drops to 15.75%, which is still a good rate on investment.

2.  Why are they not adjusting the tax-adjusted yield of 17.20% for the tax which I will be required to pay on the interest earned? 

The interest earned on Infra Bonds is taxable in the hands of investor.  The tax-adjusted yield of 17.20% does not take into account any tax payable on annual interest received.  Adjusting for the same, the post-tax tax-adjusted yield comes to 14.23% for the above series bond.  Generally no one highlights post-tax tax-adjusted yield on investment.  Have you ever seen a bank saying that the interest rate on its 1 year Fixed Deposit is 5.4% p.a. (post tax) and not 7.75% (which is the interest rate)? 

Post-tax tax-adjusted yields for the entire series bond are as follows:

 

Series	Tax-adjusted yield	Post-tax tax-adjusted yield
Series 1	15.23%	12.16%
Series 2	13.59%	11.07%
Series 3	17.20%	14.23%
Series 4	15.75%	13.25%

The above yields are again for person in the tax bracket of 30.90%.  In case a person is in lower tax bracket, the yield will be different and lower from the above.  The table below provides details of post-tax tax-adjusted yields for entire series of L&T Infrastructure Bonds at different income tax slabs.

SERIES	Tax Slabs
	30.90%		20.60%		10.30%
	TAY	PT TAY	TAY	PT TAY	TAY	PT TAY
Series I	15.23%	12.16%	12.31%	10.45%	9.86%	9.00%
Series II	13.59%	11.07%	11.36%	9.71%	9.44%	8.63%
Series III	17.20%	14.23%	13.42%	11.62%	10.23%	9.40%
Series IV	15.75%	13.25%	12.58%	10.96%	9.86%	9.07%

TAY - Tax-adjusted yield

PT TAY - Post-tax tax-adjusted yield

3. Why the yield on Cumulative option (Series 2 or 4) less than the yield on Annual option (Series 1 or 3)?

Generally, all consultants advise us to go for cumulative option since it is more beneficial. If that being the case, then why the yield on cumulative option is less than the yield on annual option? This is due to the inherent assumption in calculating the yield on the investment. The calculations assume that in the annual option, you are able to re-invest the interest earned at the tax-adjusted yield rate (i.e. @ 15.23% for Series 1 and @ 17.20% for Series 3), whereas in the cumulative option you automatically reinvest any interest earned at the rate of 7.75% for Series 2 and at the rate of 7.50% option for Series 4.

Reinvesting at higher rates may be impossible, and hence the effective yield on Series 1 and Series 3 will be lower depending on how you re-invest the interest earned.  In case you do not invest at all, the yield will be further low.

4. If the re-investment is crucial, then in which option should I invest - Annual or Cumulative?

In case you are able to re-invest the funds at rate greater than interest rate offered (7.50% or 7.75% depending on the Series in which you invest in), you should opt for the annual option. In case, you are unable to do so, or you do not wish to go in for micro-management of investing the interest every year, you can opt for cumulative option.

5. How does it compare with other investment options?

Infra Bonds are attractive only due to one reason – the benefit they offer under section 80 CCF. Otherwise there are many other opportunities available which are more beneficial. Also you need to consider the security and liquidity issue before taking the final call. These bonds are not as secured as fixed deposits and the earliest you can liquidate is the first working day after the 5th year.

Given below is the comparison of L&T Infra bonds with SBI fixed deposit for 10 years, 10 years Government of India Bonds and L&T Finance Debentures which were issued for 10 years @ 10.40% and remaining period on which is approx 9 years and current price Rs. 1082 for Rs. 1000 bond. Remember that except for L&T Finance Debentures, others are not apple to apple comparison, but will help you to make investment decision (technically though L&T Finance Debenture is also not the accurate comparison!).

Tax Slabs	SBI FD	GOI Yield	L&T Finance Debentures	L&T Infra Bond Series II
0%	7.8%	8.1%	9.1%	13.6%
30.9%	5.4%	5.6%	6.0%	11.1%
20.6%	6.2%	6.5%	7.0%	9.7%
10.3%	7.0%	7.3%	8.1%	8.6%

As you can notice even at lowest tax bracket, the lowest of the yield of L&T Infra Bond is higher than Bank Fixed Deposit, Government of India Yield and L&T Finance Debentures.

To conclude, in case you have already exhausted the Section 80C benefits and you have additional funds to invest from your debt portfolio which you are planning to invest for long term, you should invest in these bonds to the extent of Rs. 20,000 only and not a rupee more.

Comments are deeply appreciated on the above.