Inflation remains a major concern, both domestically and globally. In many large economies, inflation is at the peak of several decades. Due to which the central bank is adopting a strict policy.
Best Option to Investment in Rate Hike Cycle: The last two years have been the era of cheap interest rates. Domestic rates remained at lower levels and the government’s focus remained on growth. But when the corona virus epidemic is on the verge of ending, many new challenges have started. Factors such as rising bond yields, inflation at multi-year peak, weak global cues, rising uncertainty due to Russia-Ukraine war and rate hike by US Fed are adding to the pressure on the market. There is huge volatility in the equity market. A huge outflow can be seen from the market ahead. So, what should investors do when the rate hike cycle is on? 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 the peak of several decades. Therefore, the major central banks have adopted the path of increasing interest rates by tightening the policy. To keep inflation within the set target, the RBI has also started increasing the interest rates. Since May, the repo rate has increased by 0.90 percent.
Lending rate hiked, deposit rate stable
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 and the demand for loans is also high. In such a situation, they do not see the need to increase the deposit rate.
What are the options for investors
1. Short Duration Maturity Fund
In case of rising interest rates, investing in Short Duration Maturity Funds is a better option. It helps in reducing the losses due to increase in yield. At the same time, there is also the benefit of repeated reinvestment 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 Duration Fund
Yields for long duration funds have risen and are looking 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
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, the repo rate has increased, but the deposit rate has 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.
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.
(Author: Mayukh Dutta, Head Product – Strategy & Communication, Mirae Asset Investment Managers India)