A recent report from HSBC Global Research sees two policy rate hikes of 25 basis points each in 2018
Bond investors have been hit hard over the past one-and-a-half year. For those in fixed deposits, the interest rates have been low and bond fund investors have been worried due to tepid returns on account of rising bond yields. While ICRA predicts record retail bond issuance, experts ask investors to be selective in their fixed income investments to enhance risk adjusted returns.
“Our preferred strategy remains corporate credit, with exposure to both accrual and credit opportunity strategies,” Sunil Sharma, Chief Investment Officer, Sanctum Wealth Management, wrote in a recent investment strategy note. The note mentions slight preference for bonds on valuation concerns over stocks.Why are investors worried?
Investors saw the 10-year benchmark bond yield move up to 7.83 percent from a low of 6.18 percent recorded on December 7, 2016. Interest rates on bank fixed deposits too have started climbing up. On May 28, State Bank of India, India's largest public sector bank, raised interest rates on fixed deposits by up to 20 basis points. (100 basis points make one percentage point).
Though the Reserve Bank of India has kept policy rates unchanged so far, expectations of a rate hike in the near term are rising. A recent report from HSBC Global Research sees two policy rate hikes of 25 basis points each in 2018. The possibility of a rate hike comes in the background of an anticipated spike in inflation, rising interest rates in the US and possibility of accelerated economic growth in the Indian economy. That calls for a review of your bond portfolio.
“As interest rates are expected to rise, it makes sense for investors in the lower tax slabs to invest in fixed deposits maturing in one year. Investors will also get an opportunity to roll over their fixed deposits at a higher rate,” Vikram Dalal, Founder and Managing Director of Synergee Capital Services, said.
The bond markets are expected to remain volatile, though it may remain rangebound. If yields move up again, then bond prices will fall, which will result in a capital loss to investors. Long term gilt funds have been facing tough times due to rising yields. Over last one-year, gilt funds as a category returned 0.82 percent. However, the situation may not worsen here. “The benchmark bond yield is expected to hover between 7.5 percent and 8 percent over the next six months,” Dalal said.
Investors should see further investment options in the near future. “Reducing liquidity surpluses and rising bond yields may require non-banking financial companies (NBFCs) to tap retail bond issuances during FY19 to meet their funding requirements, given the challenges of the banking sector and overseas borrowings. Historically, NBFCs have offered 25-75 bps higher interest rates for retail investors in their retail bond issues, thereby making the instruments attractive compared to other debt instruments like bank deposits. It may also result in better investor appetite, amid limited increase in rates for bank deposits and volatile returns in debt and equity markets,” Karthik Srinivasan, Senior Vice-President & Group Head, Financial Sector Ratings, ICRA, said in a recent note.
Investors in lower tax brackets can tap this opportunity going forward. “One should ideally be laddering investments taking into account one's goals,” Joydeep Sen, co-Founder of wiseinvestor.in, said. “If you have a goal after five years, you should invest in a five-year non-convertible debenture (NCD). For a financial goal due three years from now, one can invest in a three-year fixed maturity plan or three-year NCD. If you invest across maturities you are not exposed to reinvestment risks."
Sen added that investors should be prepared to hold on to your NCD investments till they mature. "If the interest rates go up and ones has to sell, then investors may have to sell the NCD below the issue price.”If investors fall in the high income tax bracket, they may choose to invest in short term bond and credit risk opportunities funds to optimise returns. Dalal recommends investing in tax free bonds maturing in 2020-22. These bonds are available at attractive yields, he said.