Stay liquid, stagger debt mutual fund investments after every hike

Mumbai: Fund managers and analysts said investors should tread cautiously and stagger their fixed-income investments over the next 6-12 months after the Reserve Bank of India unexpectedly raised interest rates by 40 basis points.

Investors could deploy money into liquid or ultra short-term funds and after every policy announcement, gradually move to target maturity funds with a 5-10 year maturities as the central bank is expected to hike overall rates cumulatively by 125-150 basis points over the next year. This strategy has the potential to give investors a return of 7-8% annually, they said.

"Investors with long-term fixed income allocation should wait and allocate 25% of their surplus money after the June MPC (Monetary Policy Committee) outcome and keep allocating 25% each after subsequent MPC meetings," said Dhaval Dalal, CIO-fixed income at Edelweiss Asset Management. Dalal said investors could opt for target maturity bond ETFs or bond index funds maturing in 5-10 years depending on their comfort as this will help them average out their investments.

As interest rates rise, long-tenure bond funds and gilt funds would take a hit as there could be mark-to-market losses. Financial planners said investors should stay in liquid and ultra short term funds. "In the near term, liquid and ultra short-term funds are the best bet as they preserve capital," said Nirav Karkera, head of research, Fisdom. Liquid funds - considered one of the safest debt categories - invest in securities with maturities of less than three months.

Fixed-income investors have been disappointed in the past year as low interest rates meant subdued returns. As per data from Value Research, in the last year, liquid funds have returned 3.32%, corporate bond funds 2.43% and gilt funds, which bet on longer-term government securities, 1.04% as the 10-year benchmark has moved up by 140 basis points in anticipation of a rate hike.

"Rates are expected to go up further and we won't be surprised if RBI hikes rates cumulatively by 125-150 basis points in the next 12 months," said Suresh Ganapathy, associate director at Macquarie Capital.

Fund managers believe the rate hike will be slow and it will be best to stagger money on every hike. Analysts point out that the spread or difference in returns between short- and long-term debt instruments is the highest for the 5-10 year basket.

"The current levels offer an attractive real spread of about 3.3% in the 5-10 year maturity medium-long term segment and are above the long-term historical average of 1.5% - improving its relative attractiveness over short-term debt and cash," said Chintan Mehta, associate director-capital markets and asset allocation at Morningstar Investment Adviser India.

Analysts said low-cost target maturity funds are a good bet for investors.

"Target maturity funds have a defined maturity and it passively invests in bonds of a similar maturity constituting the fund's benchmark index which gives visibility of returns," said Karkera. "Chances of losses are lower if the investments are held till maturity. Since there is no lock-in for these funds, liquidity is higher."

Currently, investors could earn 7.1-7.25% on papers maturing in 2026 or 2027. For investors seeking a longer tenure, a Bharat Bond ETF maturing in April 2031 could yield 7.64%.