Time To Start Allocating To DEBT

We have all heard about how equity investments offer strong returns while posing high risk and debt investments lead to stable yet low risk returns. For investors keen on high returns, equity investments were always considered more suitable than the comparatively safer side of fixed income. However, in recent months, this tide is changing. The consistent onslaught of sticky inflation has prompted global central banks to raise their key policy rates, and this rate hike translates to a rise in the yields of fixed income assets such as government and corporate bonds, thus making the debt angle attractive for savvy investors.

Another factor at play here involves investor sentiment – a rise in rates indicates an aggressive stance from central banks, and this leads to the evaporation of liquidity and a corresponding drop in sentiment. The fall in consumer sentiment and the lack of liquidity triggers sell-off in the equity markets, precipitating volatility and a drop in prices. The culmination of these two factors ends up driving interest towards the debt side, leading to the potential for strong returns.

RBI Takes the Lead — The pandemic was a period of economic turmoil and, to keep the economy on its growth trajectory, the Reserve Bank of India boosted systemic liquidity while also lowering the repo rate significantly. This led to a strong buying movement and prompted a sustained rise in inflation. Now, with inflation consistently above the RBI’s tolerance limit, the bank has stopped injecting liquidity, narrowed the liquidity adjustment facility corridor, introduced

the standing deposit facility which is an additional tool for absorbing liquidity without any collateral, raised the cash reserve ratio of banks and, of course, hiked the repo rate. All of these actions indicate the RBI’s focus on bringing down spending in an attempt to curb inflation, which has resulted in liquidity deficits and a comparatively high repo rate at 5.9 per cent. 

Analysing the Yield Curve — This strong and persistent action amid RBI’s policy normalisation phase is affecting the yield curve, which is becoming flatter and moving upwards. Further, the short-term rates on both corporate and government bonds are moving up faster, while the long-term rates are seen moving at a relatively slower pace. According to economic forecasts and indicators regarding the current economic cycle, the economy remains on a strong footing. 

Further, the yield curve position indicates that the market is, currently, in the middle of the expansion phase. For you, as an investor, this means that there is still room for interest rates to move up. If you start your debt allocations right away, you have strong potential to realise robust returns in the short and long term. To utilise this evolving scenario optimally, savvy investors can consider debt mutual fund products such as floating rate funds, dynamic bond funds and credit risk funds.

Debt Market Outlook — The debt outlook is positive as the industry expects repo rate hikes in the upcoming meetings of the RBI on the back of high consumer prices and a challenging global environment. Despite these movements, inflation is expected to remain above the RBI’s comfort zone. Going ahead, it is expected that the short-term yield curve, which has taken the major brunt of policy normalisation, will continue to rise. However, the longer end, which has not moved much in the past, may see a significant change going forward. 

Given the higher yields across durations and ratings, debt, as an asset class, is becoming more attractive and investors should consider allocating their corpus to higher accrual schemes and dynamic duration schemes to benefit from this scenario. Further, floating rate bonds are likely to continue outperforming all other fixed rate instruments. This is because the floating rate bond funds stand to benefit from higher coupon reset. If you are unsure where to invest among the various debt offerings, then opt for a dynamic bond fund.

Such a fund seeks to benefit from interest rate volatility by managing duration dynamically. Here, the fund manager has the flexibility to manage duration between one to 10 years. Based on interest rate scenario, the scheme invests between corporate bonds and government securities. In effect, the scheme has the ability to generate reasonable returns in all kinds of market scenarios. To conclude, do not look at the past returns and miss out on the evolving opportunities in debt.

Pooja Shah
Founder & Partner, Credel Capital Financial Services LLP

The writer is Founder & Partner, Credel Capital Financial Services LLP
■ Email : Pooja.shah@credelcapital.com ■ Website : https://www.credelcapital.com