After Urjit Patel’s appointment as RBI governor-designate, the bond market witnessed a sell-off, as it became evident that there won’t be any significant change in stance
With an average annualised return of 10 per cent, income fund investors have had a couple of good years. However, considering that Consumer Price Index-based inflation is currently closer to the upper end of the Reserve Bank of India’s (RBI’s) target and the new governor is likely to continue to keep a focus on inflation, we might not see an interest rate cut any time soon.
It may be recalled that after Raghuram Rajan’s decision to quit RBI, the bond market witnessed a smart rally on expectations that the new governor might cut rates faster.
However, as became evident after the announcement of Urjit Patel’s appointment that there might not be a significant change in RBI’s monetary policy stance, the bond market witnessed some sell-off. Leaving investors with the dilemma of whether the current scenario warrants a realigning their debt fund portfolio.
Although the current scenario doesn’t appear favourable to the short-term prospects of income funds, investors will do well not to panic and must avoid abrupt decisions.
While RBI’s inflation target might not be met in the near future, a good monsoon should ensure lower inflationary pressure. Since the stance of monetary policy is likely to remain accommodative, rate cuts of 25-50 basis points can’t be ruled out over the next six-nine months.
Beside, investors must know that a major differentiator between different types of income funds is the maturity duration of their portfolios. Each category of income funds has a different risk profile and commensurate return potential.
More, income fund category has variants like duration funds, dynamic funds and accrual funds. It is important to realise that interest rate movements impact these funds differently. For example, the pause on interest rate cuts is likely to impact duration funds more than accrual funds.
Similarly, the fund manager of a dynamic bond fund has the flexibility of realigning the portfolio in line with the emerging interest rate scenario.
Besides, if one is invested in a short-term income fund, there should not be much cause for worry, as the impact is likely to much less as compared to medium and longer duration income funds.
Therefore, before making any changes, income fund investors must have a close look at the mix of funds in their portfolio. Even if one has exposure to duration funds, consider the level of exposure.
If the exposure to duration funds is, say, 10 per cent of the debt portfolio, there is no need to make any change. It is always advisable to have a combination of funds following different investment philosophies and strategies, so as to benefit from emerging opportunities, as well as to minimise the impact of events that could impact the bond market negatively.
However, for those investors who may have invested aggressively in duration funds with the hope of making significant gains from falling interest rates, it would make sense to prune the exposure and consider investing either in accrual or short-term income funds.
Needless to say, before making any changes in the portfolio, one must keep an eye on tax implications, as any gains on units sold in debt funds within three years are treated as short-term capital gains tax and are taxed at one’s marginal tax rate.
Therefore, for investors who might have completed a substantial part of this three-year period, it may be worthwhile to remain invested, as the tax incidence could be much higher than the impact of an adverse interest rate scenario on returns of the fund.
As is evident, if you are an income fund investor, you must build a portfolio that is well diversified, both in terms of maturity duration investment strategy. Remember, although monitoring is crucial, it is important to choose the right funds.
Hemant Rustagi is CEO, Wiseinvest Advisors
Illustration: Uttam Ghosh/Rediff.com