As the stock markets touch new highs some investors are looking at moving money to fixed income funds, while many others have already done a fair bit of that. Has the bull market just started or will we see a crash from these levels? No matter what your view, it makes sense for you to move a part of your folio into fixed income products where return typically range between 9-10%; i.e. ~ 2-3% higher than fixed deposit and effectively tax free if held for longer than 3 years.

Fixed Income Funds That Can be Considered Right Now

[1] INCOME FUNDS 

Typically, Income funds invest in a combination of government securities, certificates of deposits, corporate bonds and money market instruments. Fund managers actively try to manage the portfolio based on interest rate movements. Over the last 3 years, income (opportunities) funds have delivered returns in the range of 9.8 – 12 % much higher than the fixed deposit rates.

RETURNS AND LOCK-IN (Based on past returns) – Early exits i.e. before 1 year time horizon attract penalty of 1%. Risk free principal with 9.2% –10.2% return p.a. tax free if held for more than 3 years). Of course these returns can vary by up to 3% based on interest rate scenario.

Top 5 Income Funds (arranged based on 1 year returns)

Returns (in %)

Mutual Fund Scheme 6mth 1yr 3yr
Birla SL Corporate Bond Fund 5.3 11.6
Reliance Corporate Bond Fund 4.5 11.5
UTI Income Opportunities Fund 4.7 11.4 10.9
HDFC Corporate Debt Opp. 4.1 10.8 10.2
DSP-BR Income Oppor. 4.3 10.7 10.4

[2] ARBITRAGE FUNDS

Typically, an arbitrage fund is a type of equity fund which takes advantage of the price difference of a stock between cash and derivative markets. These funds can deliver returns in the range of 6% –14% p.a and are tax free if held for over 1 year. This is a good option for risk-averse investors who want to take minor risk on market volatility. If markets keep doing well, you will make better returns than debt funds; if markets crash however, your principal will still be safe in most arbitrage funds (but this is not a general rule), your returns however will fall to the extent that such funds were invested in equities without any hedging.

Taxation – As arbitrage funds are treated as equity mutual funds, they have the same taxation benefit as in case of equities. The return one earns after holding these funds for more than one year are tax-free. However, short term capital gain (less than 1 year) will be taxed at 15%. Dividends from arbitrage funds are also tax-free.

Keep in mind that arbitrage funds will give higher returns if markets are relatively unstable/volatile. When markets are stable, arbitrage opportunity is not as good.

Note – For most arbitrage funds, early exits i.e. before 1 year, attract penalty of 1%.

Top 5 Arbitrage funds (arranged according to 1 year return)

Returns (in %)

Mutual Fund Scheme 6mth 1yr 3yr 5yr
DSP Blackrock Equity Savings Fund 7.4 12.8
Edelweiss Equity Savings Adv. 3.8 6.6 7.7 9.4
Axis Enhanced Arbitrage Fund 2.7 6.3
Edelweiss Arbitrage Fund 2.8 6.3
ICICI Pru Equity-Arbitrage 2.7 6.3 7.0 8.1

[3] DYNAMIC ASSET ALLOCATION FUNDS

These funds split investments into equity and debt. Dynamic asset allocation funds follow Fund of Funds (FoF) structure which implies that the fund invests in other equity and debt mutual funds. Dynamic asset allocation funds switch aggressively between the two depending on the market situation from 0 to 100%.

Balanced Funds or Dynamic Funds

While both balanced and dynamic funds follow an asset allocation approach whereby they invest in debt and equity based on market conditions — they differ in the ways they shuffle their asset mix. While balanced funds maintain a relatively steady exposure to equity (65%) and debt (35%), dynamic funds can switch the allocation from 0 to 100 %.

Taxation– Since this fund follows FOF structure; these funds are treated as debt funds. All short term capital gains (less than one year) from the fund are added to the income and taxed as per the investor’s applicable income tax slab. Long-term gains (after three years) are taxed at 20% with indexation.

Note – early exits i.e. before 1 year, attract penalty of 1%.

Top 5 Dynamic Asset Allocation Funds 

Returns (in %) 

Mutual Fund Scheme AUM (In Cr.) 6mth 1yr 3yr
DSP Dynamic Asset Allocation 975.73 7.45 14.5 29.9
Franklin (I) Dynamic PE Ratio FOF 748.81 9.15 13.8 36.4
HSBC Managed Sol. -Moderate 206.25 14.3 19.9 12.5
SBI Dynamic Asset Allocation Fund 124.64 16.25 13.2
Birla SL FP FOF – Aggressive 117.26 16.05 20.8 49.6

[4] Monthly Income Plan

Monthly Income Plans (MIPs) are debt oriented mutual funds that invest a small part of the fund (15-25 %) in equities. MIPs offers regular income in the form of periodic (monthly, quarterly, half-yearly) dividend payouts. Read More: Comparison between Monthly Income Plans vs Fixed Deposits/ Post Office Monthly Scheme

Taxation – MIPs are debt oriented mutual fund schemes and thus the tax treatment will be same as debt funds. All dividends received from the MIP’s would be tax-free in hands of investors.

Arbitrage funds are tax free in 1 year while MIPs get the benefit of indexation (and are almost tax free) after holding the fund for 3 years. For this reason arbitrage funds are becoming more popular than MIPs.

Read more on Taxation of Mutual Fund Schemes

Top 5 Monthly Income Plans in India

Returns (in %) 

Mutual Fund Scheme 6mth 1yr 3yr 5yr
Birla SL MIP II-Wealth 25 10.8 20.4 15.2 14.8
ICICI Prudential MIP 25 9.4 16.9 12.8 12.8
HDFC MIP – LTP 7 17.1 11.0 12.1
Kotak Monthly Income Plan – Regular 7.1 15.2 11.6 11.6
IDFC Monthly Income Plan 6.5 13.4 10.9 11.5