By Jayesh Faria
THE UNION Budget this year sprung a surprise on various fixed income instruments, especially debt mutual funds, by changing the taxation norms. Incremental allocation to fixed income portfolios will have to evolve to achieve optimum risk reward ratio on post-tax basis. This will force investors to reassess their asset allocation and also readjust their post-tax returns expectations.
Debt markets still look attractive
The RBI paused rate hike in the current Monetary Policy Committee meeting, which has cooled down yields to some extent. This action has been perceived by market participants that interest rate in India will not go up in a hurry and we may be at the peak of the interest rate cycle. That is the reason the debt market has turned attractive and the yield curve has become flat from shorter to longer duration, leaving no room for gap between the two.
Global headwinds
Globally, we are still in a high-interest-rate scenario after the recent hike by the US Fed on March 22. Market expectations for peak Fed funds rate have been revised downwards by 75bps after the Silicon Valley Bank event. The failure of large banks in developed economies keeps investors away from equity markets. So it looks like a higher interest rate regime for some more quarters in the US.
Fear of failure of large banks and high interest rates have given investors in developed economics reason not to participate in the equity markets. US housing, looking at the lending rates statistics, is already pointing towards recession and the dollar index is showing signs of weakness. Majority of the currencies have appreciated against the dollar since its peak from September 2022.
Investment strategy
Investors want to be risk-averse and want to play safe in the current market scenario. In India,we have seen changes in tax regime for debt mutual funds & fixed income instruments. There is hardly any premium left for locking in rates for long term maturities. We feel that investors want to be safe on account of global and domestic factors like global central bank’s policy actions, currency, and inflation, crude oil and geopolitical events. This will keep yields volatile and MPC has also kept the doors open for future actions looking at these events forcing investors to play safe.
In the evolving market scenario, we recommend an approach where ‘Accrual’ should precede ‘Duration’ such that the average maturity of the portfolio does not go beyond five years. About 65-70% of the portfolio should be invested in a three- to five-year maturity combination of high quality (government securities/AAA equivalent) strategies . To improve the overall yield, 30% to 35% of the overall fixed income portfolio can be allocated to select high yield NCDs, private credit strategies and real estate investment trusts (REITs) / infrastructure investment trusts (InvITs).
FIXED INCOME
Yield curve has now become flat from shorter to longer duration, leaving no gap between the two
Invest 65-70% in government securities /AAA equivalent bonds of three to five years maturity
The writer is associate director, Regional Head (West), Motilal Oswal Private Wealth