Interest rate cut cycle is already underway, has the ideal time to invest in debt
funds gone by?
When the Reserve Bank of India (RBI) kept the benchmark interest repo rates firm
at 8% for most of 2014, bond funds were not receiving much investor attention, despite
the fact that we were sanguine on the bond market. The ideal time to invest in bond
funds is when debt is not doing well.
Early into 2015, RBI surprised the market with two swift rate cuts in successive
months taking the benchmark repo rate to 7.5%, and sending the bond market soaring.
This drove debt funds higher and most long-tenor income funds have been exhibiting
Now that the interest rate cut cycle is already underway, has the ideal time to
invest in debt funds passed us by? Do debt funds still have the potential to deliver
returns? Yes, because there’s enough steam still left in the debt market, and investors
should still get on the gravy train. Here’s why.
RBI had said that it would target a Consumer Price Index (CPI) inflation of around
6% for January 2016. Lately, the CPI inflation has been hovering at a shade above
5% on average for the past three months. The February 2015 CPI number has come in
at 5.37%, which is slightly higher than January 2015’s 5.19%.
The current account deficit is around 1.6% of the gross domestic product (GDP).
At $56-57 a barrel, Brent crude oil prices are now lower than last year, saving
the Indian economy billions of dollars in import bills and lowering the current
account deficit. In a few quarters from now, the government expects this deficit
to get into a surplus zone.
When most global currencies are reeling against a stronger dollar, the rupee has
been holding steady at 62.00-62.60 against the dollar. As a result of the well-behaved
rupee and lower inflation, RBI had room to cut interest rates, surprisingly by a
total of 50 basis points (bps), in the first quarter. (One basis point is one-hundredth
of a percentage point.)
While the going is good
These are not the last of the rate cuts. There’s a high probability that RBI will
cut rates further, by about another 50 bps, over the course of a year. With the
macroeconomic environment just right, there is support for a downward rate cycle.
Current account deficit getting into surplus territory will provide enough reason
for further rate cuts.
Inflation is significantly under control at 100 bps lower than the RBI target of
6% for January 2016. Wholesale Price Index inflation is in the negative territory,
coming at -2.0% for February. Last year, nobody had thought that this critical yardstick
would dip into the negative territory.
The 10-year government security (G-sec)—a key benchmark to know interest rate trends
in the economy—is down significantly in the past one year. The 10-year G-sec yield
was closer to 9% this time last year, and is currently hovering at around 7.75%.
Time for debt to bloom
When the rates will be cut precisely is anyone’s guess, but the fact that we are
heading in that direction puts debt fund investors in a sweet spot. Most use debt
funds for only two of its features. One, as these funds have fixed-income securities,
they form a part of income planning of an individual. Two, the debt investments
provide a much-needed diversification against other riskier asset classes. But the
third aspect of a bond fund is that it can provide decent appreciation, at a time
when interest rates are inching lower.
If you are a newer investor into debt funds, it’s time to hurry and make most of
the good environment. The 10-year benchmark could be around the 7% mark in about
a year. Investors have the opportunity now because interest rates are still higher;
once it starts dipping, the opportunity will slip away.
Investors have to watch out for choppiness, especially in the international economy
as the dollar gains strength and the US Federal Reserve is expected to tighten its
easy money policy. But this time, RBI is more prepared for a tightening in the US
economy, and is likely to wait and monitor the international environment before
signalling rate cuts. That should give investors enough time to invest in debt funds.
The volatility in other asset classes could also drive more investors towards debt
instruments in the coming months. Investors who prefer a conservative portfolio
should make use of this window of opportunity as it may not last long. Bond funds
with a higher average duration are better placed in a downward rate cycle. But for
those looking to diversify, a debt portfolio peppered with medium- and long-term
bond funds can be a good combination as well.
This article has also been published in MINT newspaper on 2nd April 2015.
Toll Free Number
© 2013 ICICI Prudential Asset Management Company. All rights reserved