Stick with short-term debt funds and bank FDs, for now

Amid global turmoil, the Reserve Bank of India (RBI) has chosen to keep the repo rate constant at 6.5 percent. Fixed-income investors were worried about rising bond yields in the US, rising crude oil prices and a possible impact thereof on the monetary policy review on October 6.

Despite a focus on bringing down inflation to the desired level of 4 percent, the RBI decided to maintain the monetary policy stance. Prevalent attractive bond yields make it a good time to allocate money to fixed income.

Status quo

To begin with, the RBI’s monetary policy committee (MPC) decided to continue with the stance of withdrawal of accommodation. This is done to ensure that inflation progressively aligns to the target, while supporting growth. The MPC not only left interest rates constant but also kept the growth outlook unchanged, with real GDP growth for FY2023-24 projected at 6.5 percent. Despite surging crude oil prices, erratic monsoon and a spike in prices of food items in the domestic economy, the MPC decided to keep the inflation outlook constant.

The RBI projects inflation at 5.4 percent for FY2023-2024. “Significant easing of inflation is expected in September. But indications are that throughout October-December 2023, food inflation may not see sustained easing. This requires careful monitoring of incoming data and the outlook,” said Shaktikanta Das, Governor, RBI.

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He further reiterated that the inflation target is 4 percent, though the range is 2- 6 percent.

This effectively means that the much-awaited cut in interest rates may take longer than expected.

Madhavi Arora, Lead Economist, Emkay Global Financial Services, is of the opinion that the current policy narrative is still more hinged to inflation uncertainty and liquidity management than on the fluid and uncertain global narrative as markets reprice ‘higher for longer’.

“As global financial conditions transmit with a lag, there could be further volatility ahead. Even as domestic inflation is likely to meet policy targets by end-FY24, elevated market rates and record-low interest differentials pose a headwind for the RBI,” she said.

Though the RBI has made it clear that inflation targeting remains a priority, market participants do not see further rate hikes.

Suman Chowdhury, Chief Economist and Head, Research, Acuité Ratings & Research, said: “The extent of hawkishness in the announcement has reduced with MPC sticking to its annual inflation forecast at 5.4 percent despite the uncertainty on food prices and the sharp rise in global crude oil prices over the last 2-3 months.”

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He expects the MPC to pause on interest rates. Any possible rate cut may not materialise before the first quarter of FY25, Chowdhury added.

Short-duration funds

At a time when the current bond yields are attractive, investors should make the most of them. This is the prescription given by fixed-income professionals. However, most of them are vocal about investing in schemes that focus on short- to medium-term duration.

Vikram Dalal, Founder and Managing Director, Synergee Capital Services, does not expect any reduction in interest rate in FY2023-24 and recommends investments in short-duration funds.

According to Value Research, short-duration funds have given 6.73 percent returns in the one year that ended on October 5, 2023. Short-duration funds, on an average, have a portfolio yield to maturity at 7.36 percent, which is attractive.

While investing in short-duration funds, one should check the track record, credit quality and expense ratio of the scheme.

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Deepak Panjwani, head, debt markets, GEPL Capital, prefers to look at G-Secs maturing in five years.

“The yields are inverted and the 5-year G-Sec is yielding 5 bps higher than the 10-year benchmark. If the rates are easing, a lot of demand will pop up in the shorter duration bonds and the yield curve will get aligned. The inclusion of Indian bonds on the global index will also help the yields to drift down as the 3-5 year segments will grab more attention of the foreign portfolio investors,” he says.

Constant maturity schemes tracking the Nifty 5-year benchmark G-Sec have rewarded investors with 7.1 percent returns in the last one year. Fund houses such as ICICI Prudential, Motilal Oswal and Nippon India, offer such products.

Investors can also look at investing in fixed deposits maturing in one to three years as the interest rates on offer are attractive. Do not chase yields as it may indicate higher credit risk.

Panjwani also recommends investing in tax-free bonds for individuals in high income tax brackets.

Long-duration funds

Investors keen on making money in long-duration schemes may have to wait longer. Fresh money can be allocated if yields spike in volatile times. Dalal advises shifting from short-duration to long-duration funds only on indication of a shift in the RBI stance from the withdrawal of accommodation to neutral.

Long-duration funds and gilt funds have given 7.36 percent and 6.64 percent returns, respectively, in the last one year.

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Retail investors should ideally match their investment horizon with the duration of the debt fund while investing. In volatile phases, debt funds can inflict mark-to- market losses. Long enough timeframe helps investors overcome such volatility.