Reduce return expectations, but choose fixed income for safety and liquidity: Pankaj Pathak, Quantum AMC

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Return is not the only motive behind investment in debt products. Fixed income as an asset class plays multiple roles in one’s portfolio as it provides liquidity, regular income flow and most importantly diversification to the overall portfolio. Pankaj Pathak, Fund Manager, Fixed Income, Quantum AMC, points out.

Inflation is here and there are predictions of interest rate moving up. What is your view on interest rates and inflation?

CPI inflation averaged above the RBI’s upper threshold of 6% in the last fiscal year. It has been above 6% mark in two of the past three months of the current fiscal. Clearly inflationary pressures have sustained for longer than envisaged. Given the sluggish progress of monsoon, stubbornly high crude oil prices and increased price power with corporates, there are incremental upside risks to the current inflation trend. Evidently, the RBI is behind the curve in tackling the inflation threat. Last year it was justified as we had a big economic shock and economy needed support from all fronts. This year when the economy is recovering at a steady pace and inflationary pressures have intensified, it would be difficult for the RBI to ignore inflation for long. Globally central banks are changing their tone. Some have already reduced their asset purchases and even hiked rates. I believe, the RBI will soon follow suit.

In our view, interest rate has already bottomed out and likely to move higher over next 1-2 years.

RBI wants to keep interest rates low and support economic revival. How far is this possible given the rising inflation?

It would be extremely difficult for the RBI to keep interest rates low if inflation remains elevated. To control inflation, RBI needs to tighten the liquidity and hike rates. This would not be conducive for the bond market.

There is significant supply pressure in bonds. RBI’s bond buying is helpful. But it also requires market support to fulfill this kind of borrowing requirement. With rising inflation, market will demand higher yield to absorb this elevated supply.

I think we are in a similar kind of situation we had back in 2009-10. We have very high fiscal deficit, inflation is picking up, commodity prices are up and monetary easing cycle has ended globally. There will be upward pressure on interest rates from many fronts.

For investors, investing in debt products is becoming tough. Why should investors invest in fixed income if the real yields turn negative?

Return is not the only motive behind investment in debt products. Fixed Income as an asset class plays multiple roles in one’s portfolio. It provides liquidity, regular income flow and most importantly diversification to the overall portfolio. We believe this phase of negative real yield is temporary.

For risk-averse investors, what are the best fixed income options to invest at this point?

Given the expectation that interest rates are going to move up long term debt funds carry high market risk. Risk-averse investors should focus on shorter maturity debt funds or liquid funds to avoid large market fluctuations.

The yield curve is very steep. Long term bonds are offering much higher yield than what is available on shorter maturity bonds. For instance, 5 year government bond is trading at a yield of close to 6%, while the 1 year bond yield is around 3.9%. Thus, investor with longer time horizon and an appetite to tolerate intermittent volatility can consider active funds like dynamic bond funds to gain from steep yield curve.

What is your general advice for debt investors at this point?

We have been warning investors for some time that the interest rate cycle is about to turn. So, we need to lower our return expectation form fixed income products. It would be prudent to live with lower returns for some time and wait for things to settle down. We also advise investors to look for safety and liquidity in fixed income investments as this should act as portfolio stabilizer in times of shocks. At all times keep risks under control in fixed income allocations.