Fixed Income: Go for low duration funds now | The Financial Express

Fixed Income: Go for low duration funds now

Rising rate regime makes floating rate funds a good bet

Fixed Income: Go for low duration funds now
So, when interest rates rise, floating rate funds will give higher returns than other fixed-income funds.

As the shorter end of the yield curve is likely to move up further, debt fund investors should look at low duration funds and invest in funds holding floating-rate instruments. Investors should avoid investing in long-term funds as they have higher interest rate risk.

Floating rate bonds
As the interest rates are expected to rise, floating rate funds can be useful because they can switch to the newer issuance of securities which are at higher interest rates and the older ones are automatically replenished. The returns from a floating rate fund are linked to the benchmark interest rate. So, when interest rates rise, floating rate funds will give higher returns than other fixed-income funds.

Experts say in a rising interest rate scenario, floating rate funds will provide the flexibility to manage interest rate risk by buying different tenure or duration paper. As per the market regulator’s mandate, these open-ended debt schemes have to invest at least 65% of the scheme’s total assets in floating rate instruments. Moreover, these funds provide flexibility to investors in terms of entry and exit and the duration of the investment.

Also Read: Tax Talk: Remember to pay tax on your income from side hustles

Brijesh Damodaran, managing partner, BellWether Associates, says individuals should consider investing in floating rate bonds. “The floating rate bonds are set to a benchmark. When the yield changes, the returns are also adjusted. These bonds are more suitable in a rising interest rate environment as the yield will rise. It is not typically considered in a falling interest rate scenario,” he says.

Look at short duration
Fixed-income investors should look at ultra-short term bond funds and money market schemes. Short duration funds have low interest rate risk and the credit risk depends on the credit quality of the underlying instruments. Pankaj Pathak, fund manager, Fixed Income, Quantum Mutual Fund, says investors with shorter investment horizon and low risk appetite should stick to liquid funds. “With increase in short-term interest rates, we should expect further improvement in potential returns from investments in liquid funds, going forward,” he says.

Investors should increase their investments in actively managed short duration products. Core allocation should be in high credit quality target maturity debt funds which invest in a combination of government securities (G-Secs), State Development Loans (SDL), and AAA-rated instruments. Once the interest rate cycle peaks, investors should move into medium-term or long-term duration funds.

Target maturity funds
Investors can look at target maturity debt if the investment horizon matches with the target date. In these funds the volatility tends to reduce as the fund gets closer to the target maturity. Investors who are targeting specific segments of the yield curve can invest in these funds without being locked in till maturity.

Short-term investors should match their investment horizon with the duration of the fund. These funds invest in G-Secs, bonds of PSUs, and SDLs and the default risk is lower as compared with other debt funds.

While credit risk is low in target maturity funds, investors must factor in the interest rate risk. They must consider the interest rate risks inherent in an open-ended fund in a potentially rising rate scenario if their holding period is not aligned with the targeted maturity of the fund.

Keep it short
When interest rates rise, floating rate funds will give higher returns than other fixed-income funds
Look at target maturity funds if the investment horizon matches with your target date
Once the interest rate cycle peaks, investors should move into medium-term or long-term duration funds

Get live Share Market updates and latest India News and business news on Financial Express. Download Financial Express App for latest business news.

First published on: 11-11-2022 at 04:15 IST