As long as you have a long enough investment horizon, you can begin investing in debt funds.
In anticipation of interest rate increases by the Reserve Bank of India (RBI), which formally began on May 4, 2022, yield levels have been rising in the market for a considerable amount of time. For new deployments during this time, it has become customary to pick defensive funds (liquid, etc.) to ride out the volatility. Depending on how long money was invested, it had built up a “cushion” for existing debt fund investments. Existing assets were not significantly affected, although returns were subdued due to rising interest rates and falling bond prices.
Current Scenario:
The RBI is currently in the midst of raising interest rates. In preparation for recent deployments, there may already be a tendency to take the defensive stance. Nothing incorrect about that. But it’s important to comprehend how markets operate. Markets respond before the event actually happens; they do not wait. As was already established, the yield levels in the secondary bond market have been rising for more than a year as part of the RBI rate hike cycle, which started on May 4, 2022. Similar to that, the cycle of rate increases is anticipated to persist for the following six to nine months, but the market will begin positioning itself earlier than that. As a result, you may begin investing in as long as you have a sufficient investment time horizon.
Let’s look at some data to demonstrate how the market discounts events. The benchmark yield on 10-year Government Securities was 7.1% on May 3, 2022, or the morning of May 4, 2022, before the RBI repo rate hike announcement. Even after the repo rate increase on August 5, 2022, it has already increased by 1.4%, from 4% to 5.4%. The 10-year G-Sec is currently trading at around 7.35% and has increased by about 0.25% since May 3, 2022. Put this in perspective by comparing it to the RBI rate action of 1.4%. Even if the RBI would continue to raise rates in the future, the market’s response would not cause yield levels to rise as much.
The implication is that while being conservative with your investment portfolio is perfectly acceptable, it is not necessary if you plan to ride out the rate hike cycle in defensive funds. Instead, you can adhere to the idea of a systematic investment plan (SIP) and begin taking exposure over the next six to nine months. You will be able to enter your debt funds at a substantially lower NAV if the market responds by increasing yields. The main message is that no one can predict when the market will peak or bottom.
Where to Invest?
There are numerous debt fund classifications, up to 16 for open-ended funds. Depending on your investing goals and appropriateness, you can choose any combination. Despite being open-ended, target maturity funds (TMFs) fall under a different category. TMFs have the advantage that returns are highly visible in relation to the portfolio’s YTM (yield to maturity) of the funds. Although there will be some fluctuation in returns over your holding period due to the stated maturity date, if you retain the investment until it matures, you will receive returns that are similar to today’s YTM.
Corporate bond funds and banking PSU funds are available if you’re looking for good portfolio-credit-quality funds. There are also short-term funds with a respectable portfolio credit quality. Your investment horizon should be roughly in line with the portfolio maturity listed in the most recent monthly fund factsheet. You shouldn’t assume that just because a fund category is called “short duration” that it is best suited for time horizons of, say, a few months. If your deployment horizon is brief, say a few months, you should invest in liquid, ultra-short-duration, or low-duration funds to take a defensive stance. These categories are suited for short-term investments since the impact of market volatility is minimal.
Just leave your current debt fund investments alone; no more action is necessary. Because of the market’s rising yields (traded interest rate levels), returns over the previous year or two have been subdued. Going forward, it will be considerably better for you as a result of the portfolio YTMs being higher than they were in the past.
Disclaimer: All the views in the Blog is personal of the author not attributing to anyone.
