In a surprise move, the Reserve Bank of India, on May 4, 2022, hiked the repo interest rate by 40 basis points (bp) to 4.4 per cent. So, what does this mean for your investments? Fixed deposit (FD) rates are set to become more attractive in the coming days.
“Small and mid-scale businesses, consumers and loan seekers will be substantially impacted by the RBI’s rate hike as it will result in the levy of higher interest rates on loans. The small-cap funds will also see an underwhelming response from the loan takers. The overall budgets and savings of an average investor will be in a criss-cross as they will be forced to pay a higher interest rate on a home loan or personal loan," Pramod Chandrayan, Co-Founder and CPO, FinMapp said.
How the RBI rate hike will affect mutual fund investments?
Anand Dalmia – Co-founder and Chief Business Officer – Fisdom said the primary implication of the rate hike is a tighter monetary environment where liquidity is not as buoyant and borrowing is no longer cheap. In most cases, companies sporting debt-heavy balance sheets will experience pressure on profits as interest costs soar. This, along with deeper discounting of future cash flows can be expected to affect valuations for many. Equity mutual funds having exposures to such sensitive companies will experience an adverse impact on net asset values.
“On the fixed income mutual fund side, funds with long-tenure securities and long-term gilt funds will be affected negatively. Even as the market adjusts to the policy reversal, managing the debt portfolio towards the shorter end of the curve and staggering deployment should be an ideal approach in most cases," he added.
“ The mutual fund industry will also be in deep water as the investors will be demotivated to seal in fresh money in mutual funds," said Pramod Chandrayan.
Under such conditions, very large companies that have very little debt are likely to do well. It means your large cap mutual funds are likely to perform better in the near future.
“If you have investments in small cap companies, be prepared to face some volatility and losses. If your mid cap scheme also may face rough weather. Sadly, most of these companies also face corporate governance issues during such trying times. So be very careful," said Amit Gupta, MD, SAG Infotech.
What will happen to the debt mutual funds?
“With heightened volatility across the curve, it is recommended to orient debt fund investments towards the shorter end with an average maturity within the 2.5 years range," Anand Dalmia said.
Select Banking and PSU debt funds offer a strong blend of high credit quality and duration risk-optimised portfolio. A portfolio at the shorter end with a staggered deployment approach affords the investor the ability to continually invest and reinvest at higher rates, he added.
For investors seeking a strategic debt allocation for a relatively definitive horizon, target maturity funds with a hold-till-maturity approach should offer strong post-tax returns over a period. Again, a staggered deployment in sync with scheduled monetary policy meets and rate hikes will help lock better rates, he said.
Pramod Chandrayan said losses will be incurred in overall returns by the investors invested in debt funds because of the fall in bond prices in the markets.
The existing debt fund investors must avoid any knee-jerk reaction at this point in time, It is suggested continuing to hold the investments until one’s investment horizon. Investors in the target maturity funds holding until maturity don’t have to worry as they anyway locked in at the yield at the time of investing, said Amit Gupta.
How will long-term mutual funds benefit?
Pramod Chandrayan said the least suffering will happen to those who are invested in large cap funds as these funds are invested in companies that are cash rich and can manage without taking loan on higher interest rate.
Anand Dalmia said presuming the long-term mutual fund refers to a long-term debt mutual fund, we expect higher rates to percolate effectively and contribute to overall yields on the portfolio. However, the percolation can be expected to happen at a gradual pace as more clarity emerges through the central bank’s reading of the inflation trajectory and consequent communication of its stance on the subject.
Amit Gupta suggested that one should stay away from long term debt funds and gilt funds. If you have investments, stay invested through the whole rate cycle. Otherwise, you will have to book losses.
What about short-term and mid-term?
Short and medium term debt mutual funds will be relatively less impacted versus longer term debt mutual funds given limited vulnerability to the interest rate risk, said Anand Dalmia.
Short term funds will likewise sorrow when rates go up but to a narrow scope. They will help from high short term rates as they can also support reports with high rates. These funds invest in reports with maturities between one and three years. If you are funding for a occasional years, they are a right option, said Amit Gupta.
Should you scale down your investments in equity funds?
Anand Dalmia said that unless there is a change in one’s investment profile warranting a change in its strategic asset allocation, there is no need to deviate from the determined asset allocation. For dynamically-managed tactical portfolios, we can expect the rate hike regime to spur volatility well enough to offer investors an opportunity to buy strong businesses at reasonable prices.
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