It has been an engulfing experience for the markets. Though the RBI followed the status quo as regards the key rates such as CRR, Bank, repo, and reverse repo, it has hardly made an impact on the markets.

There was widespread expectation that the central bank would follow the cues set by the Federal Reserve and cut rates. After all, the rising interest rate differential would increase inflows and this would disturb the RBI’s intention of curbing capital flows.

However, the interest rate arbitrage game (see box below), the currency carry trade game (see column by James Saft on page 10) that cause the inflows, seem to have been dulled for the moment, thanks to the subprime unwinding.

And to exacerbate things for the markets are the combination of few factors. The relentless selling of Foreign Institutional Investors (FIIs) along with the reluctance and apathy of domestic investors to rollover, has engulfed the markets in a range-bound zone. More precisely, it has been a crest-trough performance of the markets.

And this is expected to continue until a clearer picture on the US slowdown emerges and the subprime wounds start healing. The Indian growth story remains intact, even though a moderation in growth and earnings is likely to happen in this year. After 2009 and beyond would see the next capacity expansion cycle coming into play and take the growth story to another level.

Till then, equity markets would be ruled by liquidity flows, and the sentiment on this front is not as euphoric as it was at the beginning of the year.

The advice therefore is not to get distressed, reduce expectations of phenomenal gains, keep the portfolio skewed towards equities, improve your fixed income exposure, and most importantly, stay liquid and wait for the right opportunity.

There would be several opportunities to pick up attractive long-term blue-chips at lower levels when the markets correct. Opportunities will also present themselves from the IPO route.

There are once-in-a-lifetime opportunities like UTI Mutual Fund, ICICI Securities that will be up for the taking in the IPO market. Hence, staying liquid would enable you to participate in these. Already, the issues of Wockhardt Hospitals and Emaar MGF have witnessed a scaling down of offer prices. A lot many would be scaling down and getting prices to be more realistic.

Opportunities will also be created, almost overnight, when inflows start building up again and the market starts trending upwards again.

Debt warrant

Here, increasing exposure to the fixed income market, especially through fixed income funds, is seen as a smart option. “I would advise allocating at least 20% of a portfolio towards fixed income assets,” says Devendra Nevgi, CEO, Quantum Asset Management.

Some of the better performing debt funds have returned around 20% in the previous year. Now, this may not be as attractive as the equity performance, but offer strong alternative options, especially when there is uncertainty over the performance of the equity market.

?The fixed income funds have performed very well in the past months, and gilt funds have also been stellar, and I would think that these would continue to be robust,? says K Ramnathan, head fixed income, ING Vysya Asset Management.

He also believes that the central bank would reduce interest rates in the second half, as there would be compelling pressures for the central bank to do so. These would then have an impact on yield expectations and bond prices would rally.

Even the gilt funds are expected to do well. Gilt fund returns have been in the range of 10% to 14% over the past one year, thanks to the strong rally being witnessed in the yields. From a safety and surety perspective, Gilt funds offer a strong option for investors to park their funds this year.

Here again, once interest rates decline, and yield expectations ease, prices could rally, adding to the returns basket.

However, taking a bet on interest rates could prove to be hazardous in the given uncertain times.

The move by the Securities and Exchange Board of India (Sebi) to increase the investment limit by foreign institutional investors in government securities to $3.2 billion from the earlier level of $2.6 billion, is also expected to boost the market.

Ramnathan however, asserts the importance of having a perspective on the holding period before increasing exposure to fixed income related funds. He stresses that for fixed income funds, it would be prudent to have a six month to one year view and not have the same horizon as a liquid fund.

Deposit alternatives

Most fund managers, as one would expect them to, advise investors to stay away from fixed deposits. This is not without some reasoning.

The logic is that fixed deposits attract the full rate income tax and fixed income and quasi fixed income funds, though attracting dividend distribution tax, are more tax effective. With the return performance being much better than fixed deposits, the overall net returns are also better. Additionally, a lot of funds offer facilities that enable swift exit from the units and this could be an advantage.

Moreover, the trend of banks reducing bank fixed deposit rates has begun, and more banks are expected to announce further rate cuts in the days ahead. So the temporary attractiveness of the fixed deposit is likely to diminish again.

Fixed maturity plans (FMPs) also offer an alternative to fixed deposits, as they too are tax efficient, especially when one considers the indexation benefits. However, at the moment, these FMPs have not been living up to the expectations. “The FMP situation will improve after March this year,” reckons Ramnathan. FMPs are said to perform better when the domestic liquidity situation tightens a bit.

?Moreover, FMPs should be looked at as opportunistic investment vehicles that have the advantage of surety of returns,” adds Ramnathan. “Charting out a long-term strategy might not be a great idea here,? he adds.

Here, one can also avail of structured and tailored FMPs. One such is the currently open FMP33 offered by ICICI Prudential. This fund invests 20% in pure corporate debt instruments that have the highest rating, and then the rest is invested in equity linked debt products. The interest rate here is linked with average Nifty returns over a specified period. “You could participate in the growth of the equity markets and also protect your principal through the corporate debt exposure,” says Nilesh Shah, CIO and MD of ICICI Prudential AMC.

Negi stresses the need to have at least a 10% share of the portfolio in gold or related exchange traded funds (ETFs). His reckoning is that rising oil prices and weakening of the dollar influence in the global market place would trigger gold to new heights. By itself gold is not highly liquid, but ETFs offer a better option here.

The best option, reckon hardcore equity investors, is to keep focused on equity itself and to increase focus on large-cap stocks. “These offer high liquidity and have little price impact when selling huge chunks,” reckons one such hardcore equity fund manager not wanting to be named.

But then this could be hazardous as well, as a full portfolio loaded with equity becomes hugely risky. At the moment 70% equity, 20% fixed income, and 10% alternative (read gold) is the ideal asset allocation according to Nevgi.

The key mantra, however, is to lay low and remain alert. It could be the right time to lower return expectations and play out the tough times. As a fund manager exclaimed, it is time to be Rahul Dravid and graft and not become Sachin Tendulkar. These are the middle overs, the slog overs are yet to come.