Last week we discussed on investment in real estate and explained why investment in real estate at this juncture is quite risky. Just to recollect the discussion we said that real estate have surpassed its affordability factor and rental yields are at all-time low. With this asset class giving huge returns in last 10 years, it looks difficult that next 10 years would be as rosy as they have been in the past.
This week we will discuss about investment in fixed income instruments. To many investors in India, especially retail investor, it would be a surprise that fixed income investments are also not fixed but are variable. Mind you, interest rate in an economy is also an output of various factors like inflation, demand and supply of money in the market, currency market etc. Nothing is fixed, not even FD.
For example, make an FD for 1 year and renew it on maturity. Do you know how much you will get after 10 years? It is RBI which basically controls rate of interest in an economy thru Repo rate Bank Rate, SLR, CRR etc.
Fixed Deposit
Those investors who do not pay tax or fall in the 10% tax bracket can invest in Fixed Deposit. One should take up long term Fixed Deposits if they have investment horizon for that period. In medium to long term, it looks like we are in falling interest rate scenario and RBI probably will reduce interest rates further to support falling economic growth rate. One can also look at good credit rated Non-Banking Financial Institutions like Mahindra Finance, HDFC ltd etc. for getting a higher rate.
Debt Funds
Debt Funds are fixed income securities offered by mutual funds. You may be surprised to know that debt funds constitute over 70% of total mutual funds investment but common man understands mutual funds as synonymous to equity markets. In fact, corporate and HNI Investors invest a lot of their surplus in debt securities. Those with higher tax bracket can look at debt funds as they hold better tax advantage. Debt funds come with various variants. One can invest from 1 day to as long as they want. For shorter term investment one may look at liquid funds, short term plans, FMPs etc.
However long term debt funds come with two strategies – accrual and duration based strategy.
Accrual Strategy
Under accrual strategy, the fund manager aims to achieve a desired level of interest and does not generally trade in debt securities. He generally invests in debt securities with “Buy and Hold” strategy. For those investors who come under high tax bracket and do want to get decent but predictable return, can look for investment in these sort of funds. For 12 to 18 months, one can look for Templeton India Short Term Income Plan, ICICI Regular Savings Funds etc. For 3 years plus, one can go for Corporate Bond Funds of the same company.
Duration Strategy
Under Duration Strategy, the fund manager aims to achieve capital gain arising from debt market fluctuations. Here one must note that NAV of debt funds is negatively correlated with interest rate in an economy.
If interest rates are going down, NAV of debt funds goes up. This strategy is a bit aggressive in nature and can back fire as well.
It is advised to venture in these funds only when one has invested for medium to long term and also believes that interest rates are heading down. Examples of such debt funds are SBI Dynamic Bond Fund, HDFC Income Fund.
Latest Developments
On last Monday, RBI came with a policy change which came as a shock to the economy. A policy wherein RBI raised the cost of funds which was primarily done to make rupee availability difficult so that the dollar rupee exchange rate could stabilize. The rise in cost of funds on sudden basis led to rise in yields of all debt securities and hence price of the securities fell dramatically. NAVs of debt funds also saw a downfall. For those investors who have not invested in debt market can look at debt funds now for a minimum horizon of 18-24 months. They are expected to make returns in double digits.If one is able to take the benefit of double indexation, one can also get double digit tax free return.
In the end, we would urge you to understand fixed income instrument as a tool to give stability to your overall portfolio and not to create wealth out of it. In the long run, it is equity investments which creates wealth.
