Is it time for investors to revisit their debt allocation strategy?
4 min read.Updated: 23 Feb 2020, 10:42 PM ISTRenu Yadav
The debt market has seen various changes in the recent past. The sudden spike in retail inflation in Dec to 7.35% from 5.54% in Nov has surpassed the RBI's comfort level. Renu Yadav asks experts if these changes will impact the performance of debt products, including duration funds, and if investors need to revisit their debt allocation strategy
The debt market has seen various changes in the recent past. The sudden spike in retail inflation in December to 7.35% from 5.54% in November has surpassed the Reserve Bank of India’s (RBI) comfort level. In the last monetary policy, RBI put a halt on repo rate cuts, after reducing it by 135 basis points since February 2019, but it maintained an accommodative stance and introduced measures such as long-term repo operations. Renu Yadav asks experts if these changes will impact the performance of debt products, including duration funds, and if investors need to revisit their debt allocation strategy
Lakshmi Iyer, CIO (debt) and head of products, Kotak Mahindra Asset Management Co.
Don’t rejig your portfolio based on current market data
While fixed-income funds don’t assure fixed returns, the fixed-income category is suited to various interest rate cycles. For the investor, the key is to ascertain the investment horizon and the risk appetite. It is true that inflation has been inching up lately, delaying further rate cuts. Considering the macro situation and overall global growth, it is unlikely that we’ll see a rate hike in the near future. Also, the comfortable liquidity situation in the banking system offers a reasonable anchor for interest rates.
We will urge investors to base their decision to rejig portfolios on recent data. The need to review the asset allocation should arise if there is a significant deviation from the goal or if there has been a material event which changes the portfolio’s characteristics.
Given the current situation, a portfolio skewed towards short- to mid-duration funds could be potent, as such categories are usually low to moderate on both duration and credit risk. In any interest rate cycle, ensure that: “Zor ka jhatka dheere se lage."
JoyDeep Sen, Founder, Wiseinvestor.in
Bank deposit rates have eased, but may go lower
The major events in the bond market over the past year or so are RBI cutting repo rates by 1.35% since February 2019; inflation shooting up to 7.35%; attractive returns from long maturity bond funds over the past year or so; and many debt funds suffering credit events or defaults.
RBI’s policy stance on rates remains accommodative. Though it won’t cut rates as long as inflation is north of 4%, inflation will ease and there’s no need to be alarmed. Long maturity bond funds gave sanguine returns, but that’s unlikely to be repeated next year. There are concerns on inflation and fiscal deficit.
I recommend good-credit-quality short-duration bond funds with up to three to four years of portfolio maturity, as these will be less volatile than long bond funds in response to interest rate fluctuations.
Bank deposit rates have eased, but may ease more, as RBI’s rate cut (1.35%) has not been passed on fully. Small savings schemes are offering attractive rates compared to the repo rate of 5.15%. It’s good to make use of these products.
Santosh Joseph, Founder and managing partner, Germinate Wealth Solutions
Liquid funds are ideal for those investing for short term
Debt fund investors with a preference for low risk and stable returns often get confused with the dynamic nature of inflation and the impact of interest rates on their investments. When the interest rate scenario is uncertain, they can consider these options.
Liquid and overnight funds: They invest in short-term high-quality securities, so the interest rate risk is low. These are ideal for those investing for short to very short terms.
Floating rate funds: They have the flexibility to refocus based on interest rate and inflation. They invest in floating rate debt instruments whose coupon rate is revised regularly. Uncertainty in rates does not significantly impact the prices because the coupon rates are adjusted in response to market rates. There are long- as well as short-duration floaters.
Short-term debt funds (high credit quality): For a period of 12-18 months’, funds having roll-down maturity with better yields and moderate duration will buffer the effect of inflation and interest rate movement and give stable returns.
Amit Tripathi, CIO, fixed income investments, Nippon India Mutual Fund
Medium-term corporate bond portfolio best option
It may be fair to say that headline inflation and growth print bottomed out in 2019. While fiscal constraints and aggregate demand impede faster recovery in growth, credit availability has improved with RBI giving enough incentives and adequate liquidity in the system.
The probability of aggressive rate cuts is low, but unforeseen global risks need to be watched out for. The residual credit-related risks are receding with improvement in liquidity but investor confidence will take time to normalize. As such, medium-duration corporate bond portfolios (two-three years), currently benefiting from prevailing high yields and credit spreads, will be the best options in this environment.
Duration funds are unlikely to repeat their 2019 performance, but tenor compression (when yields automatically come down as time passes) will deliver some alpha there.
The best approach will be to implement a 70:30 allocation favouring short to medium duration (two-three years) versus long duration.