Bonds beckon as equity holdings get risky after rally, say experts

With interest rates expected to rise, it may be prudent to avoid long-term options, say experts

The stock market is on a tear and the momentum has taken the BSE Sensex close to the 60,000-mark in a short span. Amid the bull-run, valuations have run up and there are calls for caution while investing in equities.

Is it time to trim your equity holdings and move to safer terrain by raising your debt holding?

Though debt should always be a major component of your overall portfolio, there are a few key issues to consider before shifting to it by dumping equities. “Allocation to equity and debt in an investor’s portfolio should primarily be driven by issues such as risk profile of the asset class, the time horizon and investment objectives. Market levels should not play a role, or at most a minor role, in the allocation,” said Joydeep Sen, a corporate trainer (debt).

Asset allocation

Do not shift to debt in a knee-jerk reaction. One of the main determinants of such a move should be your asset allocation, which is fixed based on your financial goals. If the rise in stock prices has taken your allocation to stocks way above what was targeted, then you should consider selling some equities and allocating that money to bonds.

“If with the current uptick in stock prices the weighting of equity has moved higher than the desired allocation it would be prudent to re-balance the portfolio weights by booking profits on equities and reallocating to the more stable debt component,” said Sandeep Bagla, chief executive officer, TRUST MF.

Duration matters

There are expectations that interest rates could rise gradually from the end of this financial year. You must decide on the duration of your debt investment and act accordingly. It would make sense to avoid long-term government securities and gilt funds and invest in short-duration bond funds or bonds maturing in a few years, depending on your investment needs.

“It would be advisable to allocate across debt categories like money market funds, short-term funds and banking and PSU debt funds. This would add to regular income and avoid any significant fluctuations in the value of the investments. The holding period for debt funds should preferably be 3 years to avail tax benefits. The ideal overall allocation should be anywhere around 3- 5 years, which would balance the interest rate risk and earn a reasonable income as well,” Bagla advises.

Vikas Garg, head of fixed income at Invesco Mutual Fund, agrees. “Given the current steepness of the yield curve, the 2-5 years segment of the yield curve remains attractively placed from carry perspective. This segment is neither too short to be adversely impacted by low yields nor too long to be exposed to high interest rate volatility amid elevated fiscal supply. Accordingly, debt funds operating in the 2-5 year segment can provide the core allocation opportunities for the medium to long-term investors,” he said.

Tax and liquidity

If you fall in the lower income tax bracket you can invest in fixed deposits and non-convertible debentures. If you invest in small-saving schemes, be careful of the liquidity rules. Though these investments offer better returns than FDs, they score low on liquidity. Be prepared to hold till maturity.

If you are in the higher income tax brackets, you may be better off investing in bond funds with a minimum three-year time frame to earn tax-efficient returns. You can also consider investing in tax-free bonds issued by public sector enterprises that have low credit risk.

“Open–ended debt mutual funds offer higher liquidity compared to many other conventional fixed Income instruments as the investments can be redeemed anytime,” Garg said.

Investing route

You can avail of fixed income offers by investing directly or through MFs. Experts feel MFs are a safer bet for retail investors. “MFs are better investment vehicles, at least for retail individuals. Corporates or HNIs would have the bandwidth and service providers for direct investment in bonds. There are issues of liquidity in bonds that would be difficult for individuals to manage. Then there are issues of ticket size. The bond market being largely wholesale requires large deal sizes, whereas in MFs you can invest as low as, say, Rs 5,000,” Joydeep Sen said.