Strategy for
New Year 2018: Where to invest?
By Mr.Brijesh
Damodaran, BellWether Advisors LLP
Fixed income or debt
mutual funds are the go-to asset class, when linear secular income is the goal.
The years in which the
equity markets have delivered single digit return, debt funds of mutual fund
schemes have delivered double digits.
However, the year 2017
was tepid in terms of the return generated across debt funds.
Falling interest rates
In fixed income, rates
of fixed deposit have been declining. This is worrying investors who
pre-dominantly invest in them. The re-investment opportunity at the previous
rates or higher rates is no longer there with interest rates falling.
With RBI adopting the
policy of controlling inflation and status quo on rate hike being maintained,
investors in fixed income had a forgetful 2017. And what about the accrual and
duration schemes of the mutual funds?
The 10 year bond yield
has displayed a volatile range in 2017. If one is expecting the rates to be
still, any volatility effects the duration scheme.
A move towards the
north, lowers the yield to the existing investors and reduces the return to the
investor, not considering the risk of capital depreciation.
The average return in a
dynamic bond fund, which had built up a sizeable assets under management (AUM)
in the past years was in the region of 4%. Considering the tax on the income
and if you are in the 30% bracket, the returns hardly met the inflation.
When you consider
‘income’funds, the returns have been marginally higher in the range of 5-5.32%.
So what went wrong? The pause in rate cuts did not help the returns coupled
with volatility in the bond market.
However, the credit
opportunities fund as a category generated a return close to 8%. But in a
credit opportunities fund, one runs the risk of credit default and a portfolio
of AA or higher rated papers gives necessary comfort.
One should not chase
returns through the debt funds. In debt funds, it is important to have safety
of capital and assurance of secular income.
Balanced funds remain
popular
Keeping it simple did
help when investing in debt funds. Investments in the category of liquid funds,
short term and ultra-short term categories have helped generate a return of
close to 6.5%.
In a volatile bond
market scenario, it is recommended to invest in papers which will have lower
volatility and predictability of returns In this scenario, liquid funds
category fit to a tee.
Majority of the credit
paper being in the duration of 0-91 days and a few papers up to 180 days,
lowers the volatility risk. Hybrid funds with a mixture of debt and equity or
balanced funds was the new favourite among the investors.
With the equity portion
of the portfolio generating a double-digit return and the debt portion
providing the stability in returns, investors only poured more into the
balanced fund schemes.
Moreover, distribution
of regular dividends, coupled with positive taxation bias, provided a secular
cash flow linearly to the investors.
Any upward movement in
interest rates will have a short term impact on the existing debt portfolio.
Investment in debt funds are not to be considered for generating alpha.
One must look at credit
risk, default risk, and more importantly, the re-investment risk before
investing in debt products. What should be the strategy for 2018?
Interest rates could go
north in the first or second quarter if RBI re-visits the monetary policy.
Again, the decisions by the US Fed could trigger a rally in the bond market.
All of these are mere
conjecture and one needs to take an informed decision based on each investor’s
unique needs. When you need to park the funds for a duration, even up to a
year, consider liquid funds. Dynamic bond and income funds need to be
considered only post the rate hike, if any.
The writer is founder
and managing partner, BellWether Advisors LLP
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