Time still not ripe for investors to bet on long-duration debt funds

Lock into one-two year FDs and continue laddering, say experts

The Reserve Bank of India (RBI) hiked the repo rate by 35 basis points (bps) on Wednesday. This rate now stands at 6.25 per cent, up 225 bps since the start of the rate hike cycle in May.

Rate hike cycle hasn’t ended  
 

Some fund managers believe the inflation problem may persist for some time. Sandeep Bagla, chief executive officer (CEO), Trust Mutual Fund, says, “Core inflation remains sticky. Our view has been that inflation may remain stubborn owing to wage inflation and strengthening demand in the Indian economy.”
 

Fund managers expect at least one more rate hike in the current cycle. “The continuation of ‘withdrawal of accommodation’ stance indicates the rate hike cycle is not over. We expect at least another 25-bp hike in February next year," says Pankaj Pathak, fund manager, fixed-income, Quantum Mutual Fund.

Two-five-year segment is attractive
 

Future returns from debt funds are likely to be better than past returns. “Interest rates have gone up by 200-250 bps across the interest rate curve, especially up to the five-year segment. Current yield to maturity (YTM) across different debt fund categories offer attractive entry points to retail investors,” says Vikas Garg, head of fixed income, Invesco Mutual Fund.
 

Debt fund investors should continue to select a fund category that is in line with their investment horizon and risk appetite. Some segments of the market, however, appear more attractive.
 

“From a risk-reward perspective, retail investors with a medium-term to long-term investment horizon should opt for the two-five-year segment. This includes debt fund categories like short-duration debt funds, corporate bond funds, and banking and PSU funds. A large part of the returns from these funds will come in the form of accrual,” says Garg.
 

Investors who wish to lock-in the current YTMs should opt for target maturity funds.
 

Avoid tactical investments in long-duration funds right now. “After the final rate hike in the current cycle, the RBI is likely to pause for a considerable period. Therefore, taking tactical exposure to long-duration funds is not advisable right now,” says Joydeep Sen, corporate trainer (debt markets) and author. He adds that after the pause, a case would evolve for rate cuts sometime in the future, depending on inflation and other variables. “That would be the time to invest in long-duration funds,” he adds.

Go for one-two-year FDs
 

The increase in fixed deposit (FD) rates has lagged behind the rise in policy rates. High credit demand is another factor. “As long as the credit growth rate exceeds the growth in bank deposits, banks will continue to increase their FD rates to attract more fixed deposits to meet this demand,” says Naveen Kukreja, chief executive officer (CEO) & co-founder, Paisabazaar.
 

So, while the pace of policy rate increases may slow down, the same may not happen to the increase in FD rates.
 

“With FD rates on the higher side, this is a good time to lock in for a one- to two-year period,” says Adhil Shetty, CEO, Bankbazaaar.
 

Ladder your FD investments. “If you have FDs maturing at three-month intervals, you won’t face a liquidity crunch,” says Shetty.
 

Laddering will also allow you to average out the rate of return earned from FDs across an interest-rate cycle, and will remove the need to time your investments.
 

Invest in FDs primarily so that you can access the money at short notice. If you have an investment horizon for five years or more and wish to grow your wealth, opt for equity mutual funds.
 

“Especially for investors in the 30 per cent and higher tax brackets, the post-tax, post-inflation returns may still not be very attractive,” says Shetty. In the above three-year investment horizon, debt funds are likely to score over FDs due to their more favourable tax treatment.
 

Conservative investors (like senior citizens) in the lower tax brackets may lock into longer-duration FDs if they get a return of 7.8 per cent or above.