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With the interest rate cycle on the decline, Investors can still participate in the potential fixed income rally through debt funds
For the better part of 2014,the Reserve Bank of India kept the benchmark interest repo rates firm at 8 percent. While investors should have looked at investing in bond funds at that time itself, they stayed away from this mighty asset class.
As we stepped in 2015, the RBI surprised the market with two swift rate cuts - a cumulative of 50 bps in successive months. This soared the debt markets high, leading the debt funds to exhibit a superior performance. Now while the interest rate cut cycle is underway, we still continue to believe that debt funds could prove to be a good investment for investors.
Macro indicators in favour of more rate cuts
RBI has been efficiently working towards keeping the currency stable and inflation under control. Last year, RBI targeted a Consumer Price Inflation of around 6 percent for January 2016. Fortunately, inflation is already a percentage point below RBI target of 6%, hovering slightly above 5 per cent on average for the last three months. The February 2015 CPI number has come in at 5.37 percent, which is slightly higher than January 2015's 5.19 percent. WPI too is in the negative territory at -2.0 percent in February 2015. The disinflation in the global commodity prices has been a great boon for a consumer like India in terms of inflation.
The current account deficit currently at around 1.6 percent of the GDPis already well reined in, and is likely to turn into a surplus in the coming quarters if the soft crude price stays. Thanks to the crude price which is now less than 50 percent of its prices last year at around $50 levels, the Indian economy is saving billions of dollars in imports inclining the current account in India's favour.
For that matter, the Indian rupee has been quite stable at around Rs 62.5 against the dollar, amidst a scenario when most of the global currencies are limping against a stronger dollar. And indeed, it is a well-behaved rupee and lower inflation has led the RBI towards a dovish monetary policy stance.Given the perfect setting of most of the macro-economic indicators another 50 bps of rate cuts seem to be likely over the course of a year.
Invest now
We often see investors making allocation towards fixed income for diversification and income planning. However, another critical aspect of a bond fund that most fixed income investors may be over looking is that it can provide a very reasonable capital appreciation, at a time when interest rates are inching lower.
The 10-year g-sec, a key benchmark for knowing the trends of interest rate in the economy, has down trended significantly in the past one year from close to 9 percent this time last year to currently hovering at around 7.75 percent. It is a good time to accumulate a good debt portfolio on the board.
The RBI is likely to wait for a few more months before signalling the rate cut after watching the global currency scenario. But suffice it to say that this time the RBI is more prepared for a tightening in the US economy if the US Fed raises interest rates anytime soon.
There's a high probability that if the RBI cuts rates further over the course of the next few quarters, we could even see the 10 year g-sec inch closer to the levels of 7 per cent or thereabouts. That could deliver superior returns to investors holding long-term bond funds in their debt allocation. But for those looking to invest a bit more conservatively, a debt portfolio with both medium- and long-term bond funds can be just the investment strategy for our retail investors.
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Think Debt is a joint initiative between ICICI Prudential MF and Wealth Forum, which aims at sharing new thoughts and new paradigms to help the industry make deeper inroads into the large pool of conservative retail savings that offers a huge growth opportunity for the retail debt segment of the MF business.