Four things debt investors need to do as RBI rate cuts decline


The Reserve Bank of India (RBI) Monetary Policy Committee has maintained the status quo on policy rates by keeping repo and reverse repo rates at the current levels of 4% and 3.35%, respectively, as well as an accommodating position. The RBI has made it clear its intention to support growth at this point rather than focusing on controlling inflation which, at 7.6%, is well above the RBI’s comfort levels. Investors looking for clues to manage their bond allocations need to decode how RBI’s stock affects their investment choices.

“The challenge is for the RBI to ensure that the resumption of economic growth is sustainable and that would explain the accommodative stance. At the same time, there is the issue of inflation which appears to be lingering at levels much higher than expected. The other complicating factor is that the flows of FIIs (foreign institutional investors) on the equity side have been very important and there have also been flows of FDI. This has limited the RBI’s actions on interventions in the bond market, ”said Rajeev Radhakrishnan, head of fixed income, SBI Funds Management Pvt. Ltd. RBI also refrained from indicating any intention to moderate the excess liquidity in the system that has pushed yields on short term securities such as treasury bills and commercial papers below reverse repo rates. Even signaling their intention to do so may have helped them condition market expectations and possibly make any interventions less disruptive to bond markets, Radhakrishnan added. liquidity may imply a more serious impact on the market when the RBI decides to unwind it.

The confluence of recovering demand, liquidity glut, high inflation and supply-side constraints indicate a slowing of the rate-cutting cycle. Given the imperatives of growth, an impending rate hike is unlikely. Action on the liquidity front will likely be the first step, putting some upward pressure on yields from current levels. How do investors prepare their bond portfolios for the changing scenario?

expect a lower return

Investors in bonds and debt funds will have to lower their return expectations. The capital gains that have added to the yields of debt funds are unlikely to continue as the cycle of falling interest rates and tightening spreads, which leads to an appreciation in the value of bonds, is underway. much of it finished.

The rate cuts since the start of 2019 and the resulting bond value gains have translated into double-digit returns for debt fund investors. As the interest rate cycle turns, the impact on the market value of bond losses will cause yields to fall. The impact of rate changes is felt more on portfolios holding longer duration securities. “We have advised investors that debt fund returns will moderate in the 5-6% range. It is important to put liquidity and safety first, ”said Kalpesh Ashar, Sebi registered investment advisor and founder of Full Circle Financial Planners and Advisors.

Stay flexible

Fixed income portfolios need to be flexible to make the most of uncertainty. Debt fund categories like dynamic funds that have no term restrictions are well suited to navigate the changing interest rate scenario. “When rate cycles start to reverse and the portfolio needs to be adjusted to account for a bearish outlook on rates, mandate restrictions will be an obstacle. A portfolio that has flexibility over asset allocation and duration is best suited, ”Radhakrishnan said.

In the area of ​​funds other than mutual funds, the RBI 7.15% Floating Rate Savings Bonds, 2020, are also finding favor with investors looking for an accumulation product that protects them from the interest rate risk. The bond interest rates are reset every six months and indexed to the national savings certificate rate plus 35 basis points. “For the part of the debt portfolio where investors are not looking for liquidity, these bonds are suitable,” Ashar said.

choose strategies wisely

It is important to understand the interest rate and the business cycle while choosing strategies. A target maturity strategy that locks in returns at the time of investment is best suited when returns are high and investors are able to stick to them. But, currently, when returns are nearing their lowest, this strategy may not be suitable.

Likewise, it can be risky to review credit risk funds and lower rated products before the recovery in economic growth strengthens further. “Given the uncertainty in corporate balance sheets, I wouldn’t recommend taking a credit risk now,” Ashar said.

Prevent back leakage

Considering the low yield fixed income scenario, look for ways to minimize the loss of taxes and costs. Invest according to the need for liquidity and asset allocation to take advantage of the indexation advantages available on debt funds with holding periods greater than three years.

Arbitrage funds, which are taxed like equity funds, can also be considered for the short term. For investors who have a minimum hold period of three months, this category has the potential to provide better after-tax returns compared to debt fund categories suited to this duration. Select funds based on the expected holding period so that returns are not affected by the exit charges that the funds impose on withdrawals.

Short-term yields will rise slightly whenever the RBI takes decisive action to drain excess liquidity from the system. A rise in key rates will depend on a significant stabilization of growth. Falling short-term silver yields shouldn’t be of concern to investors, as liquidity and safety should be the top priority.

Investors who use shorter duration funds for systematic transfer plans should maintain liquid funds, which have a negligible market value component, to protect themselves from any impact of higher returns. The return on debt funds is expected to be around the performance of the portfolio going forward, as the potential for capital gains to add to the return is slim.

Investors should consider horizon-aligned debt funds for better after-tax returns and not be afraid of interim drops in net asset value. Don’t let the rate of return on a fixed income product alone dictate the choice.

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Carol M. Barragan

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