With RBI rate cut on cards, where you should invest to get higher return?

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Published: June 4, 2019 3:52:59 PM

The BSE Sensex on Monday closed above 40,000 points with the expectation that the RBI in the forthcoming monetary policy on June 6 might cut rate by 50 basis points.

Reserve Bank of India, RBI, RBI monetary policy, RBI rate cut, investment plans, Long Duration Bonds funds, 10 Years Gilt, Accrual FundsWhenever interest rate goes up, bond price goes down and whenever interest rate goes down bond price goes up.

With the GDP growth hitting a 20-quarter low at 5.8 per cent in 4QFY19, apart from multi-decade high joblessness, distressed agriculture sector, dwindling exports and other macro indicators pointing towards the slowdown as well, the Reserve Bank of India, aided by sub-3 per cent headline inflation, may cut the policy rates to give a boost to the economy. In fact, the BSE Sensex on Monday closed above 40,000 points with the expectation that the RBI in the forthcoming monetary policy on June 6 might cut rate by 50 basis points.

Talking on how investors may gain from changes in the RBI policy rates, Financial Coach & Corporate Trainer Prof. Rahul Ranjan said, “Bond price is inversely related to interest rate. Whenever interest rate goes up, bond price goes down and whenever interest rate goes down bond price goes up. This concept will work better when the Modified Duration is higher. So, for very Low Duration Bonds this concept will not work.”

“Therefore, it is logical that when a person anticipates that the RBI is going to cut rate, the best way to earn return for him/her is to invest in Long Duration Bonds, like 10 Years Gilt, which is a very common debt instrument in India. So, whenever it is anticipated that the interest rate will definitely go down, it is recommended that a person should go for those mutual fund (MF) schemes that invest in long duration government securities. On the other hand, if it is anticipated that the interest rate will go up, it is recommended to invest in “Accrual” Funds,” he said.

“As we are now predicting that the RBI is going to do some cut, we should invest in Long Duration Funds and Long Term Bonds. This type of situation will also give some increased return in Equity,” he added.

However, cautioning on timing the market, Ranjan said, “Successful investing is not timing the market, but the focus should be to achieve our financial goals through proper financial planning and appropriate asset allocation.”

According to Jason Monteiro AVP – Mutual Funds Research & Content, Prabhudas Lilladher, “Bond yields have already priced in a rate cut expectation, given the subdued GDP growth of 5.8 per cent in the March Quarter. Moreover, the 10-year benchmark G-sec yield has eased by over 40 bps from 7.41 per cent as on May 10 to 6.98 per cent on June 3. As a result, investors in long duration bonds would have benefitted the most over the past year, as yields have fallen substantially from over 8 per cent in September 2018.”

“The returns from Long Duration debt mutual funds and Gilt Funds seem lucrative, as over the past year the categories have generated a return in excess of 13 per cent. However, long duration debt funds are highly sensitive to interest rate movements, which a retail investor may not be able to actively track. A reversal in the direction of interest rates could lead to lower returns and even capital erosion. A duration strategy works best when one is able to predict the direction of interest rates in advance, and thus is able to maximise the returns generated through the fund. It can also be highly risky if interest rate movements do not pan out as expected. A better alternative is to let an experienced fund manager do this for you by investing in a Dynamic Bond Fund,” said Monteiro.

Thus, in the current interest rate environment one can opt for well-managed Dynamic Bond Funds, Short Duration Funds or even Corporate Bond Funds with a duration under 3-4 years and with a high credit quality portfolio.

While agreeing that traditionally, the best way to take advantage of rate cuts and falling interest rates is to invest in long duration Gilt and Income Funds or even long tenure bonds, Gaurav Awasthi, Senior Partner and Head – Third Party Products at IIFL Wealth Management, however, said, “In the current environment, it may not be a great strategy because of the fiscal constraints that are being faced by the new government.”

The medium term outlook on interest rates would depend on the fiscal deficit target that the government is looking to achieve. This will impact the long term borrowings that the government will do from the market and large amount borrowings can be negative for longer term interest rates.

“The best investment strategy would be to remain in the shorter end of the curve and invest in short term funds with an underlying portfolio of AAA bonds. This strategy will benefit both from rate cuts as well as any liquidity enhancing move from the RBI or the government,” advised Awasthi.

Talking on the investment strategy at this point of time, Dheeraj Singh, Head of Investments – Taurus Asset Management Co Ltd, said, “With 10 year govt bond yields falling below 7 per cent, a lot of the expected rate cut is already priced in. The market would now look forward to cues towards the likely future path on policy interest rates and further market action would therefore depend on the signals that the monetary policy committee gives out in their statement accompanying the monetary policy resolution on June 6.”

“If the rate cut happens to be large and more than expected and/or if the committee changes its stance to “accommodative” from “neutral”, the immediate beneficiaries would likely be gilt funds followed by generic bond funds in that order. Investors can therefore decide on their investment options based in their own view of what the rate setting committee’s actions are likely to be,” he added.

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