Some debt investment strategies on the back of rate hikes
Debt instruments have defined payout in terms of a fixed periodic coupon and repayment of principle on maturity. Hence if a debt investment is held to maturity, one can mitigate the mark to market losses, associated with market risk.
October 15, 2013 / 16:26 IST
Anagha Hunnurkar
Before we discuss the debt investment strategies, let’s have a look at the data released recently by government agencies: • To begin with India's trade deficit dipped to $6.76bn in Sept 2013 from USD 17.15 billion a year ago. This is the lowest level since last 30 months with a double digit growth in exports and decline in import of gold, silver and oil. • The Index of Industrial Production (IIP) growth slowed to 0.6 percent in August 2013 from an upwardly revised 2.75 percent pace in July 2013 • September 2013 WPI inflation at 6.46 percent Vs 6.1 percent (MoM) The core inflation rose to 2.1 percent versus 1.9 percent (month on month). Meanwhile, July 2013 WPI was revised to 5.85 percent versus 5.79 percent (prov) earlier and lastly. • The annual consumer price inflation quickened more than expected to 9.84 percent in September 2013 from 9.52 percent in August 2013. • At the same time the World Bank lowered its growth forecast for India’s GDP to 3.8 percent. • Commodity prices soften due to lower growth forecasts for China, which has been the lead importer of commodities.Clearly some of these factors are positive while some are negative to the economic prospects of the country. The equity markets chose to ignore the set of ugly numbers, on the back of expectation of robust quarterly results expected from Corporate India and announcements of banking sector reforms by the RBI governor. However the yield on 10 year Gsec hardened to 8.57 percent and the rupee depreciated by 48 paise at 61.55 to a dollar, today. With inflation not coming under control, there are constraints for softening of interest rates. With the WPI and CPI numbers released for September 2013, potentially repo could now move towards 7.75 percent when the RBI announces the monetary policy on 29th October 2013 and 10-year bond could trade closer to 8.60-8.80 percent. Overall, lowering of CAD has reduced the concerns on the rupee depreciation. At the same time the US shutdown and debt ceiling woes, though currently discounted by the markets globally, could have a potentially disruptive effect. Typically, Debt instruments have defined payout in terms of a fixed periodic coupon and repayment of principle on maturity. Hence if a debt investment is held to maturity, one can mitigate the mark to market losses, associated with market risk. However risk in debt investment increases when the income received in the form of interest does not compensate for inflation. A compensating factor of high inflation is that the reinvestment risk gets reduced as the interest rates tend to harden and the income received can be invested at higher rates. Also in times of inflationary pressures and low growth as we are witnessing currently, credit defaults may increase as the issuer is not able to service the payment obligation. Such default risks can be avoided by not investing in sectors that are already witnessing pain in servicing their debt obligations. One more driving factor for yields to drop ( causing a bull run in debt markets as prices on bonds are inversely correlated to yields) is the FII demand for G-secs and treasuries. With the US 10 –year paper surging beyond 2.68 percent , there is little incentive for FIIs to invest in debt instruments of Emerging Markets (Ems) that are witnessing a seminal currency depreciation and inflationary pressure.In this backdrop what should be the investment strategy for debt asset allocations. Since different debt instruments have varying determinants of return, some of the risks can be reduced by holding a basket of varying maturities as interest rate risk varies across tenors. Investing through the mutual fund route could minimize diversifiable or unsystematic risk. While liquid funds may generate double digit returns currently, they may result in reinvestment risk. After the July 16 2013, tightening measures announced by RBI at the shorter end of the yield curve, liquid funds too face market risks in times of interest rates swings beyond 10 bps in a day. While this is the shorter end, the overall movement in bond indices depends on the macro-economic situation, which is reflected in the growth rate. The H1 of 2013-14 has clocked a GDP of 4.4. percent . With the government committed to structural changes, which have a long term but lagged effect, appropriate monetary and fiscal policy measures are being taken to stimulate growth. Hence interest rates would soften in the long term and it would be a good idea to invest in debt fund of longer duration. However a SIP would be a better strategy to address the volatility. Cyclical factors that are being witnessed are temporary and will affect output for some time. High inflation results in higher interest rate to tackle it and will have a negative impact on growth. So an FMP to match shorter term goals could be an effective strategy.Thus the secret lies in mapping the financial goals across tenors and selecting appropriate debt instruments to match these goals through dynamic evaluation of risk and its management. The author is an investment professional from Mumbai. She is working as a Senior consultant in the area of wealth management and corporate advisory services. Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
