In a rising interest rate environment, one should look to stick to a low-duration portfolio strategy. Two-five-year G-secs offer good value as that part of the curve is still steep, said Abhishek Goenka, Founder and CEO of IFA Global in an interview with MintGenie. He expects the rupee to remain steady through the rest of the year in a 77.50-81.50 range.
Edited excerpts:
What is your outlook for the Indian rupee for this year?
We believe globally the dollar would find it difficult to climb higher from current levels as Fed hawkishness is largely priced in. A major phase of dollar strength, therefore, seems to be behind us.
Also, the RBI has done a fantastic job of managing the volatility in the rupee in these uncertain times i.e. Covid, followed by the Russia-Ukraine war and the US rate hike cycle.
We believe the RBI will continue to intervene to keep volatility in check. Moreover, we are also likely to see some respite on the current account front as commodity prices have cooled off. On the capital account front too the flow picture seems to have changed.
We have seen FPIs turn net buyers in domestic equities in July and in August thus far after nine consecutive months of being net sellers.
We, therefore, do not see runaway depreciation in the rupee. We expect the rupee to remain steady through the rest of the year in a 77.50-81.50 range.
We will not be surprised if we see some Rupee strength in the remainder of the financial year.
What does a depreciating rupee mean for investors?
Many Nifty index constituents are net exporters. IT and pharma stocks do particularly well when the rupee tends to depreciate. Therefore, for domestic companies from an earnings standpoint, rupee depreciation is not all that negative.
However, for foreign investors, rupee depreciation eats into gains from investments in domestic assets. Runaway rupee depreciation increases the uncertainty around domestic macros through its impact on inflation.
Concerns around twin deficits emerge. This increases the risk premium for investment in INR assets and depresses valuations.
How can one deal with rupee depreciation?
One can hedge the risk of rupee depreciation through OTC forwards and options or through exchange-traded futures and options. While hedging through forwards/futures one will have to enter into a contract to buy dollars at a future date.
While hedging through options one can execute structures such as long plain vanilla calls, long risk reversals or even buy-side seagulls (though seagull is not considered a perfect hedge).
Which structure to execute depends on the spot view, and market conditions (forwards and volatility) as it would determine the cost for hedging.
Hedging through forwards/futures is expensive as it entails paying the cost of carrying. Market participants look to reduce the cost by executing carry-saving hedging structures.
At a time when rates are rising, what should be the investment strategy for bonds and G-Secs?
In a rising interest rate environment, one should look to stick to a low-duration portfolio strategy.
Two-five-year G-secs offer good value as that part of the curve is still steep. Beyond that tenor, one is not adequately compensated for taking duration.
One can also consider investing in floating rate bonds. They are gaining popularity. The float has increased and so has the liquidity.
One should stick to G-secs instead of corporate bonds in a rising rate environment as generally credit spreads also tend to widen when interest rates move higher.
Can you please explain how overseas investing can be a hedge against rupee volatility and what could be its implications on returns?
When one invests in overseas assets, one has to buy foreign currency by selling rupees.
One is therefore long the foreign currency and benefits in case the rupee depreciates. While investing in foreign currency one must, however, bear in mind the opportunity cost.
Interest rates in India are typically higher than, in say, the US. One is therefore foregoing the opportunity to invest at a higher INR rate say 6%. This opportunity cost should act as the benchmark.
If one hedges the risk of rupee appreciation, in this case, one would sell the foreign currency forward and therefore receive a premium. The premium is roughly equal to the interest rate differential between Rupee and the foreign currency.
Let's say the one-year risk-free interest rate in India is 6% and the one-year risk-free Interest rate in the US is 3%, the interest rate differential is 3% and therefore the one-year forward premium would be close to 3%.
If one invests in a one-year US corporate bond yielding 5% and hedges currency risk, one would effectively get close to 8%. One can look to enhance portfolio yield through such opportunities.
Disclaimer: The views and recommendations are those of the analyst and not of MintGenie.
