Which Type Of Debt Funds Are A Worthy Investment Now…
Apr 20, 2017

Author: PersonalFN Content & Research Team

In March 2017, retail inflation data (measured by the Consumer Price Index (CPI)) rose to 3.81% from 3.65% in the previous month —the fastest uptick since October 2016.

Food prices rose to 1.93%, slower than the 2.01% increase in February, being ignited by higher fuel prices. Retail fuel inflation accelerated to 5.56%, in March, from 3.9% in the previous month.

So, the Reserve Bank of India (RBI) has been palpably wise in forecasting the inflation trajectory.

In the sixth bi-monthly monetary policy statement for 2016-17 (held on February 8, 2017), juxtaposed with expectations of a policy rate cut (by 25 bps) steered by mellowing inflation, wobbly manufacturing growth and fiscal discipline exhibited in the union budget 2017-18, the central bank refrained from reducing policy rates – it maintained a status quo. This surprised market participants, and more so as the monetary policy stance too was altered from ‘accommodative’ to ‘neutral’.

Even in the first bi-monthly policy statement for 2017-18 (held on April 6, 2017), the RBI kept policy repo rate unchanged at 6.25%, but increased the reverse repo rate to 6.0% (from 5.75%) in an attempt to tame inflation by reducing the money supply in the system.

The central bank cited that, while retail inflation is set to undershoot the target of 5.0% for Q4 of 2016-17, in view of the sub-4.0% readings for January and February, once GST regime is in force it could inflict inflation, at least initially.

Undoubtedly, the recent heat wave is likely to have a bearing on food prices. The RBI mentioned that the uncertainty surrounding the outcome of the southwest monsoon, in view of the rising probability of an El Niño event around July-August, poses a risk to inflation, particularly food inflation.

Further, according to RBI, there’s risk emanating from managing the implementation of the allowances recommended by the 7th Central Pay Commission (CPC). In case the increase recommended by the 7th CPC on house rent allowance is awarded, it will push up the baseline trajectory by an estimated 100-150 bps over a period of 12-18 months.

Besides, the general Government deficit, which is high by international comparison, is said to pose yet another risk to inflation, which is likely to be exacerbated by farm loan waivers.

Moreover, recent global developments entail a reflation risk, especially from commodity prices which may pass through on to domestic prices. But thankfully, international crude oil prices have been easing; which could be an abetting factor to alleviate pressure on headline inflation.

As for food inflation, improved procurement operations in the wake of record production of food grains will rebuild buffer stocks and mitigate food price stress, should it materialise.

So in the aforesaid backdrop, where are interest rates headed?

The inflation developments will be closely monitored by the central bank for future monetary policy stance.

For 2017-18, inflation is projected to average 4.5% in the first half of the year and 5.0% in the second half (due to an unfavourable base effect).

A higher inflation will erode the purchasing power of your hard earned money and reduce the ‘real rate of return.’

Moreover, the future course of monetary policy will largely depend on incoming data on how macroeconomic conditions evolve.

Have banks reduced interest rates?

Yes, they have making headway for the transmission of policy rates. However, there’s further scope for a complete transmission of policy impulses, including small savings/administered rates. So don’t be surprised if bank Fixed Deposits (FDs) and Small Saving Schemes earn you a lower returns.

Where is the benchmark G-Sec yield currently?

The 10-yr 7.59% 2026 G-Sec benchmark yield has hardened 10 basis point (bps) since RBI’s sixth bi-monthly monetary policy for 2016-17 and 8 bps since the first bi-monthly monetary policy statement for 2017-18.

So, which type of debt mutual fund schemes should one invest?

Well, in PersonalFN’s view, it would be imprudent to invest at the longer end of the yield curve – to put it simply, in a long-term debt fund holding longer maturity debt papers. It is vital to note that most of the rally has already been captured at the longer end of the yield curve.

Going forward, if RBI increases policy rates by any chance (enabled by the change in monetary policy stance from ‘accommodative’ to ‘neutral’) and if inflation pops up its ugly head, it could be perilous for your investments in long-term debt funds.

So, it would be better if you deploy your hard earned money in short-term debt funds if you’re risk averse, but ensure you’re giving due consideration to your investment time horizon.

For an investment horizon of upto 2 years, consider investing in short-term debt funds.

If you have an investment horizon of 3 to 6 months, ultra-short term funds (also known as liquid plus funds) would be the most suitable.

And if you have an extreme short-term time horizon (of less than 3 months) you would be better-off investing in liquid funds.

Remember, compared to banks FDs and some small saving schemes, investing in debt mutual funds can prove more rewarding and tax efficient. But you ought to take enough care when selecting winning debt mutual fund schemes for your investment portfolio, because debt funds aren’t risk-free.

If you need research backed recommendations to select best debt mutual fund schemes for you portfolio, opt for PersonalFN's DebtSelect research reports. Our superlative guidance will certainly help you on the path to wealth creation. You can be rest assured about the ethical and unbiased nature of this service.

Also, while you invest, pay heed to your asset allocation as you vie to achieve your long-term financial goals. For assistance to formulate the perfect asset allocation as you walk the path to wealth creation or rebalancing your investment portfolio, don’t hesitate to seek superlative advice from a Certified Financial Guardian (CFG), who is a mark of trust and respect.

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