There is a saying, ‘hope for the best but prepare for the worst’ and the way to prepare for perhaps things not going as well as they have in 2021 is fixed income. That's the solution actually. The investors are very attuned to investing in equities because they have lived through this TINA kind of environment - there is no alternative except equities. But now one is getting to a point where fixed income instruments are getting to be attractive. They are vying for attention and they are competing for flows as well.
How interest rates have moved across a variety of fixed income instruments?
Starting from call rate to repo to three months, six months, one year commercial paper (CP), one is basically now getting anything between 6 percent to 8 percent. If one compares where these rates were on March 31, 2022, they are up anything on an average between 250 and 300 basis points (bps). So there has been a pretty large jump.
So where does one invest?
There are many ways to invest in fixed income instruments. There are Public Provident Fund (PPF), post office savings, tax free bonds, fixed maturity plans, but there are debt mutual funds as well, which is perhaps the best way to go.
Within debt mutual funds, there are options which are available. So, the first is the overnight fund or the liquid fund. This is a product which is largely like the savings bank account. One has excess money, parks it there, takes it out when needed. The investment duration usually is between one and seven days. It invests in overnight securities.
One wants to sort of increase the time horizon a little bit. There are money market funds and money market funds, by definition – Reserve Bank of India (RBI) rules don't permit them to invest in assets with maturities more than 12 months.
They invest in things like commercial paper, certificates of deposits, treasury bills, etc. And here looking at what funds are yielding, the average is about 6.75 percent. Slightly longer duration funds - these are up to one year kind of schemes. They fall in the bucket of low duration funds. They invest in all kinds of things - bank CD's, CPs, T-bills, G-Secs, state government loans, etc.
Returns here are largely aligned to the one year certificate of deposit, which is between 7.5 to 7.6 percent or so. So, now one is getting to 7.5 and more kind of levels and then one has the one to three year kind of category, which also yields about 7.5 percent in terms of returns.
But the point is that one doesn’t know how the rate trajectory will really pan out. So, there is always the option to invest in a one year fund or a three year fund and then sort of reinvest it. For long, if one thinks that it's yielding similar or better returns.
In terms of debt mutual funds work, taxation works only on capital gains. There is higher liquidity as compared to investing directly in bonds. Many of them are very liquid instruments. And of course, there is also the investment horizon, which is extremely flexible, because, there's liquidity available when one wants it on call, one can sell these units and redeem them as one wants.
So, some amount of capital protection as the market heads into 2023 is something to keep on one’s radar. One should explore a little bit more, talk to investment advisors and perhaps take some exposure as well.
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