The importance of fixed income in your portfolio

The portfolio of fixed income MFs comprise defined-return bearing instruments like corporate bonds, government bonds, bank certificates of deposit, corporate commercial papers, etc.
The portfolio of fixed income MFs comprise defined-return bearing instruments like corporate bonds, government bonds, bank certificates of deposit, corporate commercial papers, etc.

Summary

  • The returns from this avenue are relatively more stable than other asset categories like equity or gold.

A film becomes a hit not just because of the star but also the effort of the entire crew. Similarly, your portfolio can yield optimum results only if it is well-distributed across suitable investment avenues.

The context here is fixed income investments. It is referred to as ‘fixed income’ as there is a defined coupon (interest). The returns from this avenue are relatively more stable than other asset categories like equity or gold. The portfolio of fixed income mutual funds (MFs) comprise defined-return bearing instruments like corporate bonds, government bonds, bank certificates of deposit, corporate commercial papers, etc. However, returns from fixed income MFs do not move exactly like a straight line, but with some undulations.

For MFs, there a daily net asset value (NAV), based on which fresh investors come in and some existing investors exit. The NAV reflects the market price level for that day. Hence, on the one hand, you have the proportionate coupon (interest) for one day ‘accrued’ or added to the NAV for that day. On the other hand, there is a certain market price fluctuation. The combination of the two gives the NAV. The ‘accrual’ largely takes care of market volatilities, provided you remain invested in the fund for an adequate period and unless the market volatility is severe. The ballpark guidance for adequate time period may be taken as the portfolio maturity of the fund, which is available in the monthly factsheet.

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Investors should look at fixed income investments for its benefits, and it should form a part of every investment portfolio. The extent, say for instance 80% or 20% of the portfolio, will vary as per the requirements of the investor. There are certain advantages to be reaped from allocation to fixed income: smoother investment journey, relative stability in returns; optimum risk-adjusted returns over the investment horizon; preservation of capital particularly for senior citizens; laddering of investments (i.e.. matching the maturities with cash flow timings); better visibility on returns which allow you to plan better; and suitability for short-horizon deployments or the liquid component of the portfolio.

Given these advantages, it should form an appropriate component of every portfolio. For retail investors, MF is the preferred route for fixed income investments. The bond market is largely wholesale or institutional, where trades take place in large lots, out of reach for retail investors. MFs offer the reach and portfolio diversification. Usually conservative investors, say, senior citizens, allocate a larger component to fixed income funds, but there should be a conservative component in any portfolio. 

In the wealth accumulation phase, when the investor is, say, 40 years old, the allocation to fixed income may be 40%. That, however, depends on the extent to which the investor wants to insulate the portfolio returns from the volatility of other investments such as equity or gold. In the consolidation phase of one’s career, when the person is, say, 55 years old, it is time to gradually enhance the proportion of fixed income. If the portfolio allocation is, say, 80% to equity and 20% to fixed income, at 55-60 years, it is time to gradually move to 40% equity and 60% fixed income. In the decumulation phase, when the investor is say 70 years old, the majority component of the portfolio should be in fixed income. At this stage, it is about preservation of capital. The growth of capital is relevant, but secondary in this stage.

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Currently, we are in a sweet spot for fixed income investments. As mentioned earlier, for your returns, market price movement add (when prices move up) or take away from (when prices come down) the accrual in your fixed income fund. Interest rate and bond prices move inversely. When we expect interest rates to ease, it is an even better time to invest in fixed income funds. The major variable, inflation, is under control. In March 2024, consumer price-based inflation was 4.85%, the lowest since May 2023. The Reserve Bank of India (RBI) projects CPI inflation for the year 2024-25 at 4.5%. The CPI target for RBI is 4%, and it is projected to ease to 4% by January-March 2026. Given that our real interest rate, net of inflation, is on the higher side—RBI repo rate is at 6.5%, there is a strong probability of interest rate reduction sometime this year.

We have discussed the advantages of investment in fixed income. Currently, given the view of interest rates coming down, you can allocate slightly higher to fixed income to reap the benefit.

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Joydeep Sen is a corporate trainer (financial markets) and author.

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