Higher rates can adversely impact your fixed-income savings

BANKS are quick to lower fixed deposit (FD) rates when the interest rates fall, but they take their own sweet time to raise rates when the interest rates rise.

How many times have you heard this refrain from someone, especially a retired aunt or an uncle, in the recent past? With living expenses soaring each day, most investors, especially those who swear by FDs and other relatively safer avenues like company deposits and mutual fund (MF) schemes, are in a fix. The expenses may mount, but their interest income remains steady.

They also have to worry about their investments in debt mutual funds, as a rising interest rate regime is bad news for these schemes.

INTEREST RATE SCENARIO

The Reserve Bank of India (RBI) has started raising the policy rate since February in its effort to contain inflation. It has increased the repo rate (the rate at which it lends to banks) by 1.25%, reverse repo rate (rate it pays to banks) by 1% and cash reserve ratio (the percentage of deposits banks have to keep with RBI) by 1% this calendar year to check easy liquidity.

According to investment experts, the banking regulator is likely to raise rates further. “We expect a 50-basis point increase in policy rates in the near future,” says Nandkumar Surti, chief investment officer, JP Morgan AMC. This means, interest rates — the key variable to watch out for a fixed income investor — are surely north-bound, at least, in the short term.

What do you do in such a scenario? Consider this: you can’t lock the money in long tenure FDs because you can’t take advantage of rising interest rates.

Also, you have to be very careful while investing in MF debt schemes because of the inverse relationship between the price and yield of securities. So, it is crucial that you pick instruments that match your investment horizon and risk appetite.

SHORT-TERM INVESTMENTS

If you are looking to park your money for less than a fortnight, choose a liquid fund.

The liquid-plus option is more suitable for an investment horizon of more than a fortnight. These funds can give better tax-adjusted returns than saving bank accounts. However, don’t treat these funds as investment avenues.

They are meant for parking money temporarily. For short-term investments of three months to a year, you should consider short-term bond funds.

Before investing, take a look at exit loads charged by the schemes, if any, as exit loads erode returns.

MEDIUM-TERM NEEDS

You can consider company deposits and Fixed Maturity Plans for your medium term investment needs. Company deposits pay a little better than bank FDs, but they are more risky. Always look at the credit rating of the company and don’t invest more than 10% of your debt portfolio in a single company. Also, don’t invest in deposits over a year, say investment experts.

Fixed maturity plans (FMPs) are back in vogue. Tight liquidity conditions provide a good entry point for FMP investors these days. Investors can look at FMPs for 370 days, as they can give better tax-adjusted returns. Sure, the absence of indicative yields is a thorny issue.

But remember, the yield on an FMP is a function of the credit quality of the papers in the portfolio and the tenure. One can expect better post-tax yield on an FMP than a corporate FD of similar credit quality for equal tenure.

“Though FMP are listed on stock exchanges, given the low liquidity, you may not get the exit at all or may have to exit at a price substantially less than fair price,” says Richa Karpe, director-investments, Altamount Capital Management. If you cannot remain invested till the FMP matures, avoid investing them.

LONG-TERM INSTRUMENTS

In a rising interest rate scenario, the first thing most advisors will ask you is to stay away from long-term debt schemes.

However, there are many who argue that this need not be the case. “As corporate balance sheets have improved notably, income funds make a good investment sense with a two-to-three years’ horizon,” says Devendra Nevgi, founder and principal partner, Delta Global Partner. With inflation tapering off, long-term rates are likely to ease a bit.

If you do not want to take credit risk, you can look at gilt funds that invest in government securities. Since these are issued by the government, you don’t have to fear default risk.

However, you will be exposed to higher interest rate risk than in an FMP. But gilt schemes are highly liquid. Investors can also look at non-convertible debentures (NCDs) listed on the stock exchanges.

If you choose to invest in an instrument that doubles your money in the long term, say 78 months, you can enjoy long-term capital gains, which are taxed at lower rates compared with regular interest which is added to your income.

source:economictimes.com