Navigating fixed-income investments in turbulent times

For those looking to make fresh investments, invest as per your investment horizon and risk appetite.

Fixed income or debt, as an investment category, is relatively less volatile compared with other asset classes. However, since 16 July 2013 it has been highly volatile due to some market events.

The rupee had depreciated significantly, not only due to the current account deficit problem but also on account of substantial selling by foreign institutional investors (FIIs). The Reserve Bank of India (RBI) will like to see an orderly movement of the currency and on 15 July it introduced some measures to support the rupee:

• Marginal standing facility (MSF), the rate at which banks can borrow from RBI over and above the RBI repo window, was hiked to 10.25% from 8.25% earlier; it is 9% at present.

• The funding amount through the regular repo window was capped at 0.5% of each bank’s liabilities. It was unlimited earlier.

The market reacted sharply to these measures (and some other measures as well not discussed here). The yield curve saw a complete upward shift and prices of securities came down significantly as yield and price move in opposite directions. The one-year bank corporate deposits yield, which was a little over 8% in early July, moved up steeply by 2.5%. The 10-year benchmark gilt yield, which was around 7.5% before the RBI measures, moved up by approximately 1%.

The impact of this on investments has been negative. The extent of the negative return is proportionate to the portfolio maturity of the fund you are invested in; the higher the maturity, the higher is the impact. In the process of the yield uptick, the accrual level of the portfolio moves up but it takes time for the positive impact of higher accrual to become visible in the return statement.

Let us segregate the investment advice into two categories: investors who were already invested and investors who are in the sidelines with fresh money to invest.

For existing investors, particularly in long maturity bond funds, the advice is to not book losses. It is understandable for investors to get apprehensive and develop a preference for shifting savings to bank term deposits and the like. However, as long as you have an adequate investment horizon and the value of the investment today is less than the initial amount, you would be exiting with a lesser amount to the next investment. If you remain invested for an adequate period of time, it will not only come back to its initial amount but also earn profits for you as a result of accruals and favourable market movements over a period of time. When the value of the investment was higher than the initial amount (till 15 July) you did not exit because you had a longer horizon, so why shift today at a lower valuation?

RBI has partially reversed the tightening measures. MSF rate has been reduced to 9% in two steps and shorter maturity yields (three months to two years) have recovered significantly. As and when the ceiling on daily repo funding is relaxed, there will likely be a greater pull back in the market—prices will move up.

For those looking to make fresh investments, you should invest as per your investment horizon and risk appetite. In the current volatile situation, long bonds/long bond funds should be considered only if you have an appetite for volatility. Fixed maturity plans (FMPs) are a preferred avenue now as it does away with volatility on maturity of the product and yield levels are attractive. Longer tenor FMPs should be opted for as long as it matches your investment horizon. Investment in a shorter tenor product (say one year) will be due for re-investment and interest rates may be lower at that time. In a longer tenor FMP (two to three years), you are locking in today’s high yields for a longer period. Among open-ended funds, short-term bond funds have lower volatility than long bond funds and entry levels are attractive.

Joydeep Sen is senior vice-president-advisory desk, BNP Paribas Wealth Management.