The Reserve Bank of India (RBI) alterations essential policy prices based on the situation of the economy and to supply an impetus to financial development. One of the things that influences the choice is inflation. When the inflation is higher, the RBI keeps the policy prices higher to encourage savings, so that spending reduces and similarly the demand pull inflation.
On the other hand, larger interest prices make borrowings pricey for firms, resulting in reduced production and reduced financial development.
The slowing GDP development amid higher inflation has place the RBI in a Catch-22 scenario. As a outcome, the central bank has kept the policy prices unchanged at a really low price regardless of a higher price of inflation.
As a outcome, fixed revenue instruments, which normally give the prices of interest slightly larger than that of inflation, are providing substantially reduced prices of interest, resulting in devaluation of cash invested.
“Fixed income investors face this dilemma today as conventional fixed income avenues deliver negative real returns. The three-year AAA PSU return rate is approximately 4.5 per cent, which is a part of the yield curve where most of the money gets deployed. On the other hand, inflation due to supply side constraints is around 7.6 per cent. It leaves investors with a negative real yield of about 3 per cent,” stated Nitin Rao, CEO, InCred Wealth.
So, in a low price of interest what are the possibilities of investment?
Typically, there are two approaches to enhance returns on a fixed revenue portfolio – explains Rao.
a. Increase the duration: Yields are anticipated to remain benign for a prolonged period as RBIs priority is to get development back on track in a constrained fiscal atmosphere. This implies a lot more headroom for price cuts or prolonged period of prices becoming low. Hence, growing the duration of a common portfolio from 3 years to someplace among 3 to 5 years will advantage investors with larger yield accrual and capital gains, if yields go down additional. We propose growing duration into the longer finish of the 3- to 5-year bracket.
b. Invest in reduced rated instruments: While prices on higher-rated instruments have come down due to liquidity chasing them, the other element of the fixed revenue marketplace i.e. ‘credits’ has not been a beneficiary of this liquidity. It has resulted in yields and spreads on credits remaining higher.
“This high yield and spread present an opportunity for fixed income investors as investors stand to benefit from higher accruals and yield compression as the economy gets back on track. We recommend investors to introduce 30 to 35 per cent credit in their fixed income portfolio through individual issuers or funds that have strong balance sheets, cash flows, and a diversified business,” stated Rao.
When asked if Fixed Deposit (FD) is no longer a fantastic investment alternative, Rao stated, “The 3- to 5-year SBI fixed deposit yields are around 5.3 per cent. Post-taxation, which is assumed at 30 per cent, yield comes to around 3.7 per cent. In context of inflation highlighted above, a post-tax yield of 3.7 per cent would imply negative real returns. So, fixed deposit cannot be termed as an optimal investment in the current scenario. Investors must ideally bank on high-yield investments.”
So, what is the suitable move – to exit or invest?
“Investors should consider moving into more yield-enhancing avenues to maintain their purchasing power. Exiting is not a choice at all as it will further bring down the effective purchasing power of an investor. Debt or Fixed Income is definitely an important portion of Asset Allocation. Investors should consider distributing their investments across different rating profiles and different periods to optimize their returns,” stated Rao.
“One can also consider investing in products of similar organisations in the secondary market e.g. investing in secondary market papers which give you a slight increase in returns over fixed deposits. For example if you invest in SBI Perpetual Bonds over SBI Fixed Deposits then the return will be about 2 per cent higher. A logical selection of similar or marginally lower investment papers in the same organisation will give you better returns,” he added.