Russia-Ukraine war has resulted into economic sanctions on Russia – a key producer of crude oil and gas. Crude Oil is boiling. The prices are well above $110 per barrel and in India an increase in fuel prices is round the corner. Globally prices of soft commodities are also on rise. This is expected to push up inflation. Though the experts may differ on the quantum of the uptick in inflation, they agree that inflation is not going to go away soon. That is enough for investors to sit and take notice. Here is how you can be better prepared.
Bonds: The main victim of high inflation
In 2019 and 2020, long-term debt and government securities (g-sec) funds gave 11 percent returns. It was a great time to be invested in such debt funds when interest rates were falling. But things may get tighter, now that inflation is rising steadily. In 2021, the long duration funds gave 3.21 percent, as yields hardened.
A low interest rate and high inflation combination is bad for investment returns. Although debt funds give tax-efficient returns as compared to bank fixed deposits and small-saving instruments, their post-tax yields during low interest rates are quite low. Worse: if interest rates rise, then these funds may decline in value. “Fixed income investors should avoid locking in money for the long term. Instead, they must stick to liquid funds to benefit from gradual increase in interest rates in future,” says Arvind Chari, CIO, Quantum Advisors.
Here are two alternative strategies for your fixed income allocation:
If you have money to park for the short run, liquid and overnight funds are still tax-efficient, especially if you fall in the highest income-tax bracket. Stick to short-duration debt funds, if you want to park your money for smaller timeframes.
Avoid chasing high yields in fixed income, via, say, credit risk funds. These funds come with higher risks. Use debt funds to balance your overall portfolio’s risk, not to earn higher returns.
Feroze Azeez, Deputy CEO, Anand Rathi Wealth Management says, “Though rising inflation lowers the real yield on bonds, it also enhances the indexation benefit. Bond funds work due to their indexation benefits.” Dhaval Kapadia, Director-Managed Portfolios, Morningstar Investment Adviser India, recommends investments in instruments offering floating interest rates, such as RBI Floating Rate Saving Bonds.
Good time to buy a house
Some experts say that in inflationary times, prices of real assets such as land, real estate, gold tend to rise. Ritesh Jain, Ex-chief Investment officer and blogger at WorldOutOfWhack.com says, “That’s a good time to buy a residential property with a home loan, if your cash-flow permits.”
If you wish to buy a house for consumption, then this is as good a time as any. But if you wish to invest in real estate, do your research well. Vishal Dhawan, Founder and Chief Financial Planner, Plan Ahead Wealth Advisors says, “Investors would be better off investing through real estate investment trusts (REIT), as they offer access to high-quality commercial real estate assets and you also enjoy intermittent liquidity.”
Jain believes an allocation to gold works well, too, in high inflationary times.
Don’t ignore equities
Stocks did well in CY2021. But since the beginning of the CY2022, the volatility came back as the US Federal Reserve started talking about reducing liquidity. Some risk capital in emerging market was expected to go back to developed markets. The process of flight of capital has started and we have seen foreign institutional investors selling in Indian markets. Since January 1, 2022 flexicap equity funds have lost 7.02 percent.
Correction in stock prices can be a good point to enter the stocks. But investors should be measured in their approach and stagger their investments in equities through diversified equity funds.
Don’t fall for the temptation of thematic or sector funds. Stick to diversified funds, instead. Shridatta Bhandwaldar, Head Equities, Canara Robeco Mutual Fund says, “In inflationary times, businesses with pricing power tend to do well. Investors may also make money with quality cyclical stocks.”
“Avoid any knee-jerk reaction. Inflation is also cyclical and so do not go overboard on any particular asset class or investment,” says Dhawan.
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