Debt or equity: The way forward in times of economic uncertainty

Over the last one year,average return generated by gilt funds stood at 13.3 per cent and that for income funds was 12.1 per cent

Written by Sandeep Singh | Published:June 17, 2013 4:56 am

Over the last one year,average return generated by gilt funds stood at 13.3 per cent and that for income funds was 12.1 per cent,with schemes of various fund houses generating returns in excess of 15 per cent. Therefore,for an investor who has earned over 15 per cent return on his debt investments over the last one year,the expectations for a repetition of similar returns in the next year would be there.

However,the developments over the last couple of weeks — a sharp depreciation of rupee against the dollar (6 per cent in the last one month) and its expected impact on widening the current account deficit — has raised concerns over the legroom available with RBI to cut interest rates when it comes out with its mid-quarter monetary policy review today.

Keeping that in mind,experts feel that debt investments won’t be able to duplicate returns generated over the last one year and investors will have to keep moderate expectations and be more rational. In such a situation,what should be your investment strategy?

View on Rate cut

There is a growing consensus in the market that RBI does not have enough scope to go for a rate cut in the upcoming policy review.

Research houses expect that the trade deficit for May can rise to $21 billion from $17.8 billion in April 2013 and that may lead to a widening of current account deficit of 5.5 to 6 per cent for the second quarter of FY’14.

“Given the fact that trade deficit was high in May and current account deficit is likely to rise,it reduces the probability of RBI reducing policy rates in their upcoming policy announcement,” said Ashish Pathasarthy,treasurer,HDFC Bank.

There are others who say that even in the near future the extent of rate cut may be limited.

“With CPI still printing above 9 per cent and record low in rupee,we expect a maximum of 25 basis point cut in policy over next three months with nil probability of cut in June policy,” said Ritesh Jain,CIO,Tata Mutual Fund.

The hopes of a rate cut got flushed out when RBI governor said that inflation is not decelerating even as growth is decelerating. He also said that a large CAD is the biggest risk factor to the economy today.

Expectations from debt

While the debt schemes of mutual funds generated returns in excess of 15 per cent over the last one year,it is not something that debt normally offers. A large part of those returns came as RBI cut the interest rates by 125 basis points over the last 14 months. While the broader trend for the interest rates is still downward,the extent of the rate cuts may be limited,going forward.

Experts say that investors generally invest in debt for stable and decent returns and market timing is important while investing in income funds.

“The phenomenon of high returns from debt does not happen every year. Look at debt to provide stability to your portfolio and meaningful post-tax returns,” said Amar Pandit,founder and CEO,My Financial Advisor adding that investors can still earn a comfortable 9 per cent post-tax return by investing in debt over the next one year.

“We do believe that there is still some rally left in government bonds if rupee were to stabilise even at current levels. We are not bullish on credits and believe the corporate bond spreads will widen over next three to six months,” said Jain.

“I think the realistic expectation from duration funds should be close to double digits.”

While the foreign institutional investors have exited in big numbers from the debt market,experts call for focus on good papers.

“Go through mutual funds to invest in AAA-rated good papers with a time horizon of one to three years,” said Pandit.

Should you look at equities now?

In the last 10 trading sessions,the benchmark Sensex at the Bombay Stock Exchange fell by around 7 per cent or 1,388 points and market experts say that corrections in the equity market should now be seen as opportunities to invest for the long term.

A recent report,Bank of America Merrill Lynch says that while rupee volatility raises near-term risk to inflation and to a rate cut this month,the worst may be behind us.

“The markets will be volatile in line with global trends and near-term we may see some more correction. However,after the 6 per cent correction,we are pricing in a lot of bad news,” said the report prepared by Jyotivardhan Jaipuria,head of research at Bank of America Merrill Lynch.

There are others who believe that some pain may still be there in the short-term.

“We believe that economy has still not bottomed out. Political uncertainty and policy paralysis is further holding back investment which is not good for equity markets from short term perspective,” said Jain.

But investors are likely to benefit if they enter with a long-term perspective. Pandit says that any money that is not required by the investor for the next 10-15 years should be invested in the equities and the preferred route should be mutual funds.

However,if one is looking for direct investment in stocks,experts say that investors will have to be cautious and not try to be adventurous.

“Present times call for investing with sector leaders and non-leveraged balance sheets. Although the valuations of these companies is not cheap but reasonable clarity of future earnings still give us comfort of investing in these companies,” said Jain.

Also since the rupee has depreciated significantly over the last one month,investors need to stay away from companies that have high forex debt. “Companies which have raised forex debt for domestic business would be hit as net worth of these companies will get eroded,” said the BofAML report.

Disclaimer: Views expressed are in a personal capacity and should not be relied upon to make investment decisions

Key takeaways

Market experts say that corrections in the equity market should now be seen as opportunities to invest for the long term

Investors are likely to benefit if they enter with a long-term perspective (10-15 years) in equities and the preferred route should be mutual funds

Companies which have raised forex debt for domestic business would be hit as net worth of these companies will get eroded,says a BofA ML report

Investors will have to be cautious and go for sector leaders and non-leveraged balance sheets

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