Now, for an investor, this may seem like a ‘non-event’ as it may simply mean nothing changes. But a ‘no action’ in this instance, can cause some action on some of your debt funds, as you may have observed post May 22.
Here’s how a pause on policy rate cuts matter to you and what should be your stance.
Delay in rally
The renewed rally in gilts (government securities) and long-term bonds in recent times (at least until May 22) was a result of few events or expected events: one, there was robust FII activity; two, the RBI had resorted to rate cuts and there were enough indications of more in the offing. Three, open market operations done by RBI was infusing liquidity thus easing yields.
But post May 22, the fall in the rupee by close to 7% reversed some of these events or the expectations. One, FII interest fell with outflows seen in the debt market. Two, the RBI had to pause to take stock of the evolving currency situation locally and globally. The RBI cannot, at this juncture, afford to cut interest rates simply because a rate cut will infuse more rupee liquidity and make the rupee cheaper against the dollar, thus worsening the rupee’s slide.
So for you, as an investor, a pause in the rate cut means no immediate rally in your gilt funds or long-term bond funds (those with a high portfolio maturity of say 8-10 years). In fact, you could well continue to see the kind of volatility (where NAV dropped anywhere between 0.01% and 1%) you saw in the past fortnight in these instruments.
Rate cuts remain due
But relax, if you have a more than one-year view, you will have little to worry and here’s why: For one, the RBI has hinted its bias towards rate cuts as it remains concerned about the poor GDP growth as well as industrial production numbers. The RBI has stated that its monetary policy will continue to address growth issues, provided inflation recedes in a sustained manner.
Now the silver lining is that inflation has indeed been on a downward trajectory barring food inflation. Food inflation accounts for close a fourth of headline inflation and would therefore be a key component to help keep inflation at bay. With a strong monsoon promised, better forecasts on this front is likely to provide some confidence to the RBI.
Hence, the 50-basis point rate cut forecasted by economists for this year will likely happen, although with delay and at a more gradual pace.
If you hold debt funds or intend to buy into debt funds you could consider one of the following strategies that fit you:
Time frame of less than one year
If you are holding long-term gilts funds or bonds and your goal is nearing within the next few months, then you would be safer moving to ultra-short term or liquid funds to avoid volatility in the former over the next 2-3 months.
If you are investing afresh with a less than 1-year time frame, then gilts and bonds can be risky. Use ultra short-term funds (6-9 months) or short-term debt funds (1 year). The short-end of the curve should provide decent returns with less volatility as short-term liquidity requirement will continue as companies with unhedged foreign currency liabilities will require funding (given the rupee fall).
Time frame of more than one year
If you are already holding medium to long-term bonds with a time frame of 1-3 years or more, then this short-term volatility should not cause panic. While rate cuts may be delayed, they need to happen for the economy to accelerate. Any selling now would amount to selling cheap as discussed in our earlier article – To be or not to be in the market.
But as a general rule, avoid excessive exposure to gilt funds as these are only tactical investment avenues.
If you wish to invest afresh, go for medium to long-term income funds which will have a good mixture of both government securities as well as corporate bonds, rather than pure gilt funds.
Our call on ‘Funds for risk-taking debt investors’ given in end May remains the same. But please note that these funds are not suitable for long-term investors with medium risk appetite.
We would recommend that such investors pick from our Select Funds list – ‘Debt long term’ category.
If you are a new investor in the markets and have a long-term view, then you should necessarily have equities in your portfolio now. Besides the fact that equity valuations are trading below India’s long-term averages, the best time to invest in equities is when the worst of the news is out.
We have seen dip in earnings growth and economic growth, fall in the rupee and also an inflation peak out. Hence, if you do not have any exposure to equities, then kick-start an SIP with a balanced fund or MIP to get a dose of equities or simply use FundsIndia’s Shubh Aarambh portfolio.