Rising interest rates: How investors can benefit with 5R’s

Bekxy Kuriakose, Head – Fixed Income, Principal Pnb AMC, shares 5 factors investors should remember when interest rates are rising.
By Guest |  21-02-18 | 
 
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This post has appeared in the India Markets Observer 2018, an online publication that brings together experts who discuss these challenges in the fund industry and investing insights and various perspectives. 

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In recent months we have seen interest rates rising in the debt market. Gilt yields have risen more than 80 bps over last one year. Corporate bond yields have risen 40-50 bps. Short term rates have moved 15-30 bps too. Debt schemes particularly those with longer duration have been impacted as rising rates mean lower prices and MTM (Mark to market) losses leading to lower returns.

As we start the year, this maybe an opportune time to evaluate your savings and investment portfolios. For many investors fixed income products like bank fixed deposits, Public Provident Fund, small saving schemes of government, etc may also be a significant chunk of their savings.

There are five main factors that investors should keep in mind while evaluating their portfolios and to ensure they benefit from the recent rise in interest rates:

Repricing

How quickly have the various modes of savings been repriced to the new rates? To give an example, the Gross YTM of debt funds have gone up in range of 20 to 70 bps over the past one year due to rise in interest rates.

However, we see that bank fixed deposits have not quite followed this path. While bulk FD rates (more than Rs 1 crore) still remain quite low, retail FDs of some banks have gone down during the same period. Since April 2016, the government has also been calibrating rates on small savings schemes downwards on a quarterly basis. And as market yields have gone up the differential between both have been contracting.

Riding over the interest rate cycle

There is a tendency for investors to consider mutual fund schemes as short-term investments. While investors willingly lock-in to illiquid products for 15 to 20 years the same approach is not considered when investing in mutual fund schemes. This needs to change. Interest Rate cycles undergo changes with changes in the economy and no investor can perfectly time entry and exit basis this factor. Hence remaining invested over longer periods of time ensure that the short-term pain of fall in prices is offset by the longer-term benefit of compounding and subsequent recovery.

The 3-year to 5-year returns of most debt funds have been well maintained inspite of recent rise in yields.

Repayment

Do you have borrowings/loans which are linked to floating rates? Has your bank/loan provider recently hiked these rates? If yes repaying fully or partly and reducing such liabilities maybe a prudent strategy.

Risk Management

Two types of risk should be kept in mind when evaluating debt funds- interest rate risk and credit risk. When interest rates start rising, sovereign assets like government bonds and AAA rated corporate assets are the first to react being liquid and having more frequent issuance.

Also, in this cycle we have seen long-term gilts and corporate bonds prices falling more as well due to higher duration.  Lower rated corporate assets typically take more time to rise as these are relatively illiquid and the absolute yields may still be attractive for investors. A balanced asset allocation is, therefore, key to spreading risk and maintain balance.

In the current environment investors should consider a mix of liquid, low duration, short term funds with a topping of dynamic bond funds.

Reward Yourself

Is your money lying in savings bank account at low rates?  Time to move perhaps to liquid funds where your money can earn higher returns and can also be withdrawn at short notice.

With this checklist you can be well prepared to weather the recent rise in yields and continue on the path of achieving your financial goals.

Happy investing!

This post has appeared in the India Markets Observer 2018, an online publication that brings together experts who discuss these challenges in the fund industry and investing insights and various perspectives. 

Download your FREE copy Now!

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