Listed Bonds vs Debt MFs – Is There a Tax Alpha?
- Otto Money
- Jun 27
- 3 min read
Updated: Jul 24
IntroductionIn our earlier post, we discussed why post-tax returns matter and how investors can improve them. This is especially relevant in debt investing, where returns are modest and tax rates can be high.
One option we didn’t explore previously was investing directly in listed bonds. With Budget 2024 lowering the long-term capital gains tax on listed bonds from 20% to 12.5%, the appeal of this route has grown. This is particularly timely, as the RBI cut the repo rate by 0.5% in June 2025, setting the stage for a declining interest rate environment, which is generally good for bond prices.
So the question arises: Do listed bonds offer better post-tax returns than debt mutual funds? Let’s take a closer look.
Returns and Taxation of Debt Instruments
Debt instruments give returns in two main ways:
Periodic Coupon Payments
These are regular interest payments and are taxed at your income tax slab rate.
For mutual funds, these coupons are not taxed until you redeem your investment, which helps defer taxes.
Capital Gains
These occur if you sell the bond at a higher price before maturity, often in a falling interest rate environment.
Bond prices go up when interest rates fall (and vice versa)
Now here’s the key tax difference:
Listed bonds held directly get capital gains taxed at 12.5% (if held long-term).
Debt mutual funds pay slab-rate tax on capital gains, even if the gain is from falling rates.
The Study
To quantify the difference, we compared:
A direct listed bond investment vs. a debt mutual fund.
₹1,00,000 invested over 5 years in both cases.
The bond has a 10-year maturity and a 6.5% coupon rate.
We modelled a falling interest rate scenario: interest rates drop by 0.25% per year.
Slab rate is assumed to be 30% and LTCG tax rate is 12.5%.
Mutual fund charges are assumed at 0.3% per year, not applicable for direct bond holders.
Listed Bond – Post-tax Value
Debt Mutual Fund – Post-tax Value
Comparison & Insights
Despite the tax benefit on capital gains for listed bonds, the net gain over 5 years compared to a debt mutual fund is marginal - about 0.02% more in annualized (CAGR) returns in this best-case falling rate scenario!
An directly bought Listed Bonds come with additional challenges:
Liquidity: Not all listed bonds trade actively. Exiting may not be easy.
Pricing: Bid-ask spreads can be wide, and prices may not reflect fair value.
Research burden: You need to analyse yield curves, bond quality, issuer risk, and market timing.
Debt MFs, in contrast:
Offer daily liquidity.
Provide professional management and diversification.
Are far more convenient and accessible.
Conclusion
Listed bonds seem, on the surface, to offer a slight tax edge in certain scenarios like falling interest rates. But the difference is simply negligible and one has to consider the effort, complexity, and risks involved in managing a direct bond portfolio.
Exposure to debt via other tax efficient MF instruments continues to be our preferred way of debt investing. As they say, half of finance is tax arbitrage!
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