NEW DELHI: The Reserve Bank of India’s (RBI) recent rate hikes have left many investors confused as far as their investment portfolio is concerned. Though the impact of inflation on the investment portfolio isn’t direct but it can happen in many ways. Inflation impacts different asset classes differently, so the adverse effect can be moderated by having the right combination of instruments in one’s portfolio.
As the RBI increases interest rates to counter inflation, some of the debt instruments have become attractive.According to experts, people are now shifting to fixed income instruments such as debt mutual funds, government bonds, corporate bonds, fixed deposits and savings accounts, among others.
But it is not easy to guess how much the RBI will increase the interest rates in future even if inflation remains way above the central bank’s tolerance level of 6%. The central bank has already increased the repo rate by 140 bps and further hikes are expected in the current financial year. So, what should be the strategy for retail investors to make most of the changed scenarios, and invest in debt assets?
FDs back in focus
After the 140 bps increase in repo rates – the rate at which RBI lends short-term money to banks – most banks have increased the fixed deposit rates by 15-20 basis points since June. Though the FD rates for most tenures are still below 6%, it is likely that the rates may go up further as banks hike FD rates with a lag.“Since banks have raised deposit rates one can start investing in FDs,” says Jitendra PS Solanki, author of ‘Financial planning for the families having children with special needs’ and a Sebi-registered investment advisor.
According to Pankaj Murarka, founder of Renaissance Investment Managers, there is a lag by banks in increasing interest rates in FD due to high systemic liquidity. In that context, investors should invest in medium- and long-term bonds and also start investing in FDs. A few corporate FDs are also offering 6.5-7.5% rates in 1-3 year tenure. But corporate FDs always have higher risk of default, and therefore, investors should invest only in high-rated FDs.
Government and other bonds
The yields on 10-year government bonds have been trading over 7% for quite some time and are currently around 7.2%.Some experts believe it is a good time to invest in long-term G-sec bonds. They expect the 10-year government bond yield to continue to trade in a broader range of 7.1%-7.5%. As many economists and analysts see the overnight rates moving closer to 6% -- currently the repo rate is at 5.4% -- yields on shorter duration government bonds are likely to move higher.
“With 10-year yield going high, anyone with a long-term horizon can invest in long-term G-sec bonds and expect good returns when interest rate cycles reverse,” said Jitendra Solanki.Currently, yields on government bonds across all tenure are higher than bank FD rates.
“Bond markets are ahead of central banks and they are already discounting peak interest rates. Due to this, yields have peaked out and will remain stable in the short-term and might decline in the medium-term,” Murarka adds.
Debt funds
Debt mutual funds offer an array of funds to suit one’s investment horizon, risk profile, etc. Therefore, at a time when the interest rate risk is high, you can choose one or more debt fund options to make yourself immune to the uncertain interest rate scenario. “To protect oneself from interest rate hike, investors can temporarily park funds in high quality debt funds in low duration category like liquid fund, ultra-short duration fund & Money Market Fund. Once the rate hike cycle is over, investors can then consider investing in long duration debt funds,” Pankaj Shreshta - Head-Investment Advisory Division - Prabhudas Lilladher.
According to him, investors can also consider investing in floating rate funds to navigate rate hike cycles. Pankaj Pathak, Fund Manager- Fixed Income, Quantum Mutual Fund says that investors with a short-term investment horizon and with little desire to take risks should invest in liquid funds which own government securities and do not invest in private sector companies which carry lower liquidity and higher risk of capital loss in case of default.
