Investors, avoid long-term funds

If you plan to invest in an FD, go for the 12-15-month tenure.
This will allow you to redeploy maturity proceeds at higher rates (if rates rise), advises Sarbajeet K Sen.

The 10-year government bond yield has risen to around 6.2 per cent.

With interest rates expected to rise this year, investors need to recalibrate their fixed-income strategy.

What has caused the spike?

In the Union Budget, the government announced it would borrow another Rs 80,000 crore during the current fiscal year, which surprised the markets.

The government plans to borrow Rs 12.06 trillion in 2021-2022 (FY22).

At 6.8 per cent of gross domestic product, the fiscal deficit for FY22 is higher than expected.

The government set a fiscal deficit target of 4.5 per cent for 2025-2026 in the Budget, indicating that the fiscal deficit will remain elevated.

The market cannot digest all this supply itself and requires support from the Reserve Bank of India.

What triggered the sell-off was that the market expects the RBI to announce an open-market operations calendar.

"The supply of bonds is set to increase and that is creating pressure. The market expects the RBI to provide an upfront commitment on the quantum of support it will provide, but that has not happened so far," says Pankaj Pathak, fund manager-fixed income, Quantum Mutual Fund.

Interest rates are expected to move up during the year. Experts, however, say the rise will be gradual.

"The ultra-accommodative monetary policy deployed by the central bank after Covid-19 will have to be rolled back sometime in the future, when the recently improved demand conditions find stronger footing. This, however, will be done gradually as the economy will need supportive monetary and fiscal policy for a reasonable period," says Siddhartha Chaudhary, head-fixed income, institutional business, Sundaram MF.

Time to book profits

If you have been riding the falling interest rate regime so far by investing in long-term bond and gilt funds, it is time to book profits.

Also, avoid investing in gilt funds based on past returns as hardening rates could cause losses.

Long-duration bond funds and gilt funds have lost 2.71 per cent and 1.46 per cent in the one-month period ended February 22, according to Morningstar.

Invest at shorter end of curve

Experts say it is time to get defensive.

"Being defensive means investing in shorter maturity instruments," says Joydeep Sen, corporate trainer (debt market) and author.

You should now invest in low-duration funds and money market funds, which invest in bonds maturing in six to 12 months and up to one year, respectively.

The yields are attractive and the portfolio gets repriced in less than a year.

You may also allocate some money to a short-duration bond fund with average duration of two years.

Investors looking for high yields, who have the necessary risk appetite, may invest in credit risk funds.

Instead of investing in individual non-convertible debentures and fixed deposits, they will be better off investing in these funds, which could offer better post-tax return over a three-year period.

Avoid locking in for long term

If you plan to invest in an FD, go for the 12-15-month tenure.

This will allow you to redeploy maturity proceeds at higher rates (if rates rise).

If you invest in company FDs, stick to quality names.

Avoid investing in long-term bonds and FDs, which typically offer higher rates.

If interest rates rise, you will not be able to reinvest at higher rates.

Also, go for laddering, which refers to investing in fixed-income instruments that mature at regular intervals.

This reduces reinvestment risk. You will get cash flows at regular intervals, which you can reinvest at varying levels of yield.

Over the long-term, you will earn a decent average return.

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