Strategize Your Debt Investments Carefully

The Reserve Bank of India has raised its lending and borrowing rates four times since March 2010. The last one was in July when it raised its short-term lending and borrowing rates by 0.25 per cent and 0.50 per cent respectively. Though the RBI has been following the strategy of boosting borrowing costs in a calibrated manner to maintain the current growth momentum, the persistent inflationary pressure is most likely to compel it to go for further tightening of rates in its monetary policy review due in September.

The expectation of another hike in the benchmark interest rates by the RBI and the never-ending supply of bonds have been putting pressures on the bond prices. No wonder, the yield on 10 year benchmark bond has climbed to 8.03 per cent. However, some softening of the wholesale price based inflation is expected when the base effect wears off in another quarter or so. Though the moderation in inflation has slowed down because of recent hike in the petrol prices, the wholesale price index can be expected to be in the range of 6-7 per cent by the end of this fiscal.  A normal monsoon would also help in moderating the food prices. It’s times like these when investors looking to invest in debt funds must tread carefully. Here is an analysis of some of the most prominent options in the debt category and what should be the strategy to invest in them in the current scenario.

Debt Funds
These funds primarily invest in debt instruments issued by corporates, banks and financial institutions. There are different types of debt funds and the suitability of each one of them depends on investors’ time horizon. For example, liquid funds are suitable for a time horizon of up to three months, ultra short-term bond funds are suitable for 3-6  months, short term bond funds are ideal for a time horizon of 6-12 months and medium term debt funds can be an ideal option if the time horizon is one year or more. Among these funds, medium and long-term term debt funds are most impacted by the interest rates movements. Hence, one has to carefully analyze the prevalent interest rate scenario at the time of making investment. In the current scenario, where the yields have risen beyond 8 per cent, one can consider investing in these funds after the impending rate hike by the RBI.[PAGE BREAK]

FMPs
For investors who wish to earn higher returns on a time horizon up to one year and that too without any volatility on account of interest rate movements, Fixed Maturity Plans (FMPs) can be a good bet. FMPs normally have a series of quarterly/half-yearly and yearly plans.  FMPs aim to generate predictable returns and at the same time protect investors from the interest rate volatility. For investors who intend to invest for a time period of more than one year, the right strategy would be to wait for some time as they can get better returns. However, before investing in FMPs, one has to be sure about the time horizon as premature withdrawals are not allowed in these schemes.

MIPs
Monthly Income Plans (MIPs) are basically ultra conservative balanced funds wherein the debt portfolio provides a steady return and the equity portfolio enhances the chance of improving overall returns. While MIPs cater to investors who require a regular income, these funds also have the characteristics of providing multiple solutions. For example, for an investor who wishes to build his capital over a period of time, the growth option under a MIP provides the most ideal vehicle. There are different variants of MIPs. The major difference could be on account of level of exposure to equities. Generally MIPs have an exposure to equities ranging from 10 per cent to 25 per cent.  A conservative investor will do well to start investing in those MIPs that have capped the equity exposure to 10-15 per cent.

This asset mix, over a period of time, has the potential to provide returns that are more attractive than other options like fixed deposits and debt funds. However, there is a possibility of fluctuations in the returns in the short-term due to certain market factors. Therefore, one must have a time horizon of around 2 years to get the best from these funds.