The topic of rising interest rates is the talk of the town. Experts believe the huge government borrowing programme for the financial year would push interest rates higher. Rise in bond yields after the announcement of Budget 2021 is an indication of the same.
“Interest rates would be under upward pressure due to the huge government borrowing programme. There is a possibility of interest rates rising, but that would be very slow and gradual,” said Joydeep Sen, corporate trainer (debt market) and author.
If interest rates rise, you would need to alter your investment strategies in fixed income since most investors have got used to falling interest rates in recent times.
Here’s how you can align your money matters to benefit from the rising interest rates:
Do not lock in rates for long
As far as possible, avoid investing for longer tenure. If you lock in all your money now, you will keep getting the same rate of interest, even if the interest rates later move up. To avoid such a situation, invest in non-convertible debentures and fixed deposits maturing in 12 to 15 months. If the interest rates go up, then you can invest the maturity proceeds of these fixed deposits at a higher rate of interest.
Avoid gilt funds
Among bond funds you should avoid gilt funds and long duration bond funds. Over the three years ended February 26, 2021, these funds gave 9.27% and 9.1% returns (CAGR), respectively, as per Value Research data. Though the past returns have been good, these funds are best avoided, as they invest in long term bonds and such bonds respond to interest rate changes the most. In a rising interest regime, these may lead to losses to investors.
Liquid funds were offering returns less than the rate of interest payable on deposits in saving bank accounts towards the end of CY2020. However, things have changed now. The rates are expected to go up and these funds should work as short term parking spaces.
“Rising interest rates will have an adverse impact on existing bond/bond fund investments. Interest rates and bond prices move inversely. However, since the upward movement in interest rates over the course of the year would be very calibrated, supported by the RBI, investors should not panic,” said Sen.
If you want to invest with a one year view, then money market funds and low duration funds make sense. Since these invest in bonds maturing in less than one year time frame, they are expected to be least impacted by rising interest rates.
On the backdrop of abundant liquidity pumped by central bankers globally, if inflation rises faster than the interest rates, then soon investors will see a negative real rate of returns. In such a case your fixed income portfolio loses in terms of purchasing power of money. To tide over this, you may want to allocate some money to gold and equities through mutual funds in a staggered manner.
Invest in liquid instruments
In a rising interest regime, the rates on both fixed deposits as well as loans rise. If you have floating rate loans, then keep a track of them. Soon these loans too will charge higher interest rates. If the hike is going to be steep, then you would be better off using some of your fixed income investments to retire high cost loans. For that, your fixed income investments need to be liquid.
Choose well-managed credit risk funds
Though the interest rates will take some time to go up, do not try to chase high yields. Avoid investing in un-rated fixed deposits and bonds. Instead, invest in credit risk funds if you want high yield. In that case, you at least benefit from diversification.
“Investors may either play safe or take a limited exposure to credit risk funds of AMCs with a good track record in the default cycle,” said Siddhartha Chaudhary, Head, Fixed Income, Institutional Business, Sundaram Mutual Fund.
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