Debt market will become investor’s choice in the era of rate hike, these are better options

Talking about the last two years, there has been an era of cheap interest rates. There was a big cut in rates domestically and the entire focus of the government was on growth. The corona virus epidemic is almost on the verge of ending, but many new challenges have started. bond yield ,Bond Yields), inflation at several-year highs, weak global cues, rising uncertainty due to the Russia-Ukraine war and the US Fed (US FedFactors such as hike in rates are increasing the pressure on the market. There is huge volatility in the equity market. Heavy outflow can be seen from the market ahead. Debt market is under pressure for mark to market loss. In such a situation, when the period of rate hike is also going on, then what should investors do. Can Debt be a Market Option?

inflation a big concern

Inflation remains a major concern both domestically and globally. In many large economies, inflation is at a decade high. In April, the rate of inflation in India was 7.97 percent, while in April the inflation rate in the US was 8.3 percent (the highest since 1981). Therefore, the major central banks have adopted the path of increasing interest rates by tightening the policy. At the domestic level too, the focus of the Reserve Bank (RBI) is on controlling inflation instead of growth. In order to keep inflation within the set target, the RBI has also started increasing the interest rates.

Lending rate hiked, deposit rate stable

According to Mayukh Dutta, Head Product Strategy & Communications, Mirae Asset Investment Managers India, the rise in inflation was due to higher crude prices at the beginning of the year. On the other hand, inflation increased due to increase in the prices of food items. It is estimated that the inflation rate will remain high for some time. In such a situation, to control it, interest rates may also continue to increase. One effect of this will be that the lending rate will increase. But this does not seem to be happening in the case of deposit rates i.e. deposit rates.

Banks have sufficient liquidity

Banks have sufficient liquidity (surplus money for disbursement) and the demand for loans is also high. In such a situation, they do not see the need to increase the deposit rate. A hike in the lending rate may increase the cost of borrowing for corporates. Due to this, economic growth can be affected. On the other hand, due to efforts like reduction in fuel excise duty, increasing LPG subsidy and food and fertilizer subsidies, the revenue of the government will also come down, which can increase government borrowing.

What does this mean for the investor?

Like equities, the debt market also goes through different phases. The recent rise in domestic and global bond yields has led to a fall in the returns of traded bond and debt funds. The most common way of investing in equities is by investing strategically to take advantage of market volatility and get returns based on the economic cycle and sector exposure. Similarly, better risk adjusted or risk adjusted returns can be achieved if invested in the right funds of debt scheme category on the basis of interest rate cycle.

Consider these options in the current market environment-

1. short term maturity fund

In the event of rising interest rates, investing in short term maturity funds is a better option. It helps in reducing the losses due to increase in yield. At the same time, the benefit of frequent reinvestment is also available on high yield. Such funds invest in short term papers and as the scheme matures, the money is reinvested in better yielding papers.

2. hold the paper till maturity

To reduce the interest rate risk, one can invest in funds that follow accrual strategy (holding paper till maturity and benefit of coupon payment). Funds that follow a buy and hold approach can be a better investment. In this, the investor stays invested till the maturity of the money pay, from which the coupons of the papers can be availed.

3. SIP in Long Term Fund

Yields for long term funds have risen and look attractive. Although there is volatility in the market right now, but investors who are aiming for the long term can invest in long duration funds through SIP to reap the benefits of higher yields. Investing for a long period will reduce the risk of current market volatility, while holding till maturity will also benefit from changes in rate cycles. With this, the investor will also get the benefit of rate cut phase in future.

4. Debt funds instead of guaranteed returns now

Investors looking for traditional investments such as options with guaranteed returns can consider debt funds. In fact, there is a huge lag in transmission of rates (changes in the interest rate of banks by RBI) in options with guaranteed returns. Debt funds reflect interest rate changes quickly. Talking about the present, there has been an increase in the repo rate, but the deposit rates have remained stable. Deposit rates may remain the same till there is surplus liquidity in the market. The debt market shows real time reflection of yield rise, making it a better option in such a situation.

Debt funds can give returns in every interest cycle

It is a misconception that investors can benefit from debt mutual funds only in the event of a cut in interest rates. Investors can choose from different debt fund categories according to their risk profile and investment goals to build a diversified portfolio, which can be wealth creators even in different interest rate environments. Equity has taught investors to think long term through Systematic Investment Plan (SIP). The same holds true for debt investments by long-term investors with a mix of buy and hold and long duration. It gives them a mix of coupon and long debt experience, as long as they understand the volatility of the debt.