The headline WPI Inflation has always been a fertile data point for the bond yields to pave their path. And for the Government and the central bank of our country (Reserve Bank of India), this data point has huge relevance when it comes to running a country or governing the banking and financial system.
At present the RBI as well as the Government - both are quite uncomfortable with the WPI inflation remaining above the 8.0% mark.
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Increase / (Decrease) since March 2010 | At present | |
Repo Rate | 175 bps | 6.50% |
Reverse Repo Rate | 225 bps | 5.50% |
Cash Reserve Ratio | 100 bps | 6.00% |
Statutory Liquidity Ratio | (100 bps) | 24.00% |
Bank Rate | unchanged | 6.00% |
We believe that RBI would not take any hawkish measures (while increasing policy rates), which could hurt the economic growth rate of our country. And reason for believing so is that, WPI inflation is likely to mellow further in the coming months (by May 2011) as the base effect fades away. Hence in that sense we believe further rate hikes aren't likely to be witnessed for at least some time, as the rise in interest cost would derail economic growth as borrowing cost would scale-up.
Liquidity too has remained tight since October 2010, and is expected to remain tight till end March 2011. Thus any increase in policy rates would cause a situation of "taps drying up". Hence, that again makes us believe that interest rates are peaking out.
Thus in such a scenario what should be your strategy while investing in debt mutual funds?
Well, now it's the time to gradually take exposure to pure income and Government securities funds, as interest rates are almost peaking out, making longer tenor papers look attractive. Longer duration funds (preferably through dynamic bond / flexi-debt funds) can be considered, if one has a longer investment horizon (of say 2 to 3 years).
Type of Fund | Time Horizon | Liquidity requirement |
Liquid Funds | less than 3 months | Very High |
Liquid Plus Funds | 3 to 6 months | High |
Floating Rate Funds | 6 to 12 months | Medium |
Short-term Income Funds | Strictly 1 year and above | Medium |
Fixed Maturity Plans of 3 months to 15 months | Hold till maturity | Medium |
Dynamic Bond / Flexi-Debt Funds | 2 to 3 years | Low |
Pure long-term Income Funds | 3 to 5 years | Low |
Government Securities Funds | 3 to 10 years | Very Low |
Whereas, if you have a medium term investment horizon (of over 6 months), you may allocate your investments to floating rate funds.
Short term income funds should be held strictly with a 1 year time horizon. While one can even consider Fixed Maturity Plans (FMPs) of 3 months to 1 year (strictly hold till maturity) as the short term rates are attractive and these FMPs can generate attractive yield for the investors. 13 to 15 months FMPs can also be considered in order to gain attractive post tax returns by availing the double indexation benefits.
One should invest in longer duration funds, if the time horizon is of over 2 to 3 years. But you may witness some volatility in the near term as there is always an interest rate risk involved in the longer maturity instruments.
So be a prudent investor! Please do not trade on interest rates, but on the contrary play the interest rate cycles wisely by investing in debt mutual funds. This will help you generate safe and regular flow of income over the period of time.
PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.
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