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What should be your fixed income investment strategy?

What should be your fixed income investment strategy?

By Suresh Sadagopan   IST (Updated)

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One needs to choose the right product to invest into based on the liquidity needs.

People invest in debt instruments to get stable returns. But all debt instruments do not offer stable returns. Some debt instruments like Debt funds are volatile due to interest rate cycle and other reasons. But, debt funds cannot be avoided as they have their advantages. We need to pick and choose the fund subcategories that would work well now.
Interest rate movement affects debt instruments. However, predicting interest rate movement, especially over the long term is difficult. The current scenario signals an upward trajectory. A hike in the interest rate will have an impact on one’s current Debt Mutual Portfolio in the Short to Medium term.
The following are some of the factors that may impact debt products -
  • Crude oil prices spiking further - Given that India is the world's third-largest oil importer, such a hike will inflate the import bill and disrupt the fiscal position. Inflation is expected to go up which in turn will spike up the interest rates.
  • Foreign outflows - Outflows from domestic capital markets will also have an impact on the debt market. Foreign portfolio investors (FPIs) net sold shares worth Rs. 166.15 crore while domestic institutional investors (DIIs) bought equities worth Rs. 149.58 crore in April 2018, provisional data showed.
  • Strengthening US Dollar - The rupee is near the 69-mark against the dollar, amid high demand for dollars from banks and importers. In fact, the Indian currency has fallen by 8 percent against the greenback in 2018 so far and is one of the worst performing currencies this year across the world. Some experts do not rule out the rupee to weaken further to a new low to the psychologically key Rs 70 per dollar.
  • Trade deficit - Trade deficit widened to $ 14.62 billion in May ‘18 from $13.72 billion in April ‘18, which is a negative for inflation/ interest rates.
  • Interest rate hike on US Treasuries - The Federal Reserve is slowly increasing the interest rates on it's treasuries which will cause a flight of capital from across the world including India. This will strengthen the dollar and weaken the rupee. This may cause the interest rates in India to move up so that Indian GSecs will be competitive.
  • GOI borrowing program - The government of India's borrowing in this year is expected to be high considering that we are about 12 months away from national elections and populist measures absorbing a lot of money can be expected. This will again cause the interest rates to harden.Debt funds have an inverse correlation to interest rates and hence interest rate hikes are not great from the point of view of debt funds. However, we may have to stay invested in debt funds for liquidity and short term goals.
  • For this, one may choose funds with shorter tenure portfolios, good asset quality with accrual strategy of investment in the fund. Such funds would be affected the least in an interest rate upcycle. Also, one may avoid Govt securities as much as possible as they are extremely sensitive to interest rate movements, especially the ones with a longer duration.
    The other option available in Debt MF space is Fixed Maturity Plans ( FMPs ).
    A good alternative to Open Ended Debt Mutual Fund Schemes -
    Fixed income investors with low to moderate risk profile may, therefore, take some exposure in Fixed Maturity Plans (FMPs). FMPs are close-ended debt mutual funds with a maturity period which could range from one month to five years. These funds usually invest their corpus in highly-rated securities, AAA corporate bonds, certificates of deposits (CDs), commercial papers (CPs), and the like. There are those which may invest in lower quality papers too and may give higher returns. But as a general rule, one may consider high quality portfolios to ensure safety of investments and interest payments.
    Advantages of investing in an FMP -
    • Indexation benefit on capital gains, if investment tenure is more than 3 years. Most FMPs are over 3 years tenure.
    •  Lower expense ratio.
    •  Many FMPs invest in highly rated bonds/ papers and hence credit risk is likely to be low.
    • Closed Ended Fund - The intervening interest rate volatility may not affect returns profile of the scheme. Scheme is cumulative and returns come at the end.
    • Units will be listed on Stock exchanges and provides an exit option. But then, liquidity is low & hence one should invest here with the idea of holding it to maturity.
    • FMPs are available at the moment and the returns offered by the papers that they would be putting money into indicates that they may be able to offer 8.1-8.4% or thereabouts pretax, and is likely to offer about 7.4-7.5% after LTCG tax ( depends on the inflation position in the next three years ) . FMPs are best suited for those who do not want regular cashflows & liquidity in between.
      B. Other options before you -
      • Tax free bonds from secondary markets - offering about 6.3% tax free
      • Perpetual bonds from secondary markets - offering pretax returns of about 8.8%-9% now ( for higher quality bonds )
      • Corporate FDs ( High Credit quality ) - offering pretax returns of 8.3-8.5% now.
      • The above three options may be considered if regular income is needed. These are the other options available, apart from bank FDs. The first two will offer only annual income and the third would offer monthly/ quarterly payments.One needs to choose the right product to invest into based on the liquidity needs, risk they are willing to take, taxation, income needs etc. A good portfolio would have the right mix of these funds so that it is most suited to one’s needs.
        Suresh Sadagopan is a Certified Financial Planner and runs Ladder7 Financial Advisories, a fee-only financial planning firm.