The growing focus on inflation has prompted the Reserve Bank of India (RBI) to increase interest rates on short-term debt funds. This explains that mutual fund investors can now alter their fixed-income portfolios by investing more in liquid funds and target maturity funds. However, those willing to take more risks to earn higher returns may park their money in credit risk funds.
Explaining how one’s risk appetite has a bearing on the allocation of funds, Nirav Karkera, Research Head, Fisdom said, “Investors could allocate to liquid /liquid plus categories for their short-term needs and gradually add to target maturity funds over the next 3-6 months to help lock in higher rates.”
The advice for renewed fund allocation comes in the wake of events that have triggered fund managers’ expectations of a rate hike in government bonds. Explaining how some government bonds are now giving a seven per cent interest rate, Akhil Mittal, senior fund manager (fixed income), Tata Mutual Fund said, “The RBI is expected to increase the repo rate by 50 basis points this financial year.”
With inflation going beyond control, the government is on a liquidity controlling spree by tightening the short-term rates, thus, prompting a buying interest among liquid fund investors. However, rising interest rates may adversely affect long-term schemes including gilt funds that bet on government papers and income funds. A hike in interest rates does not gel well with long-term funds investments. Financial experts explain that when bonds yields rise, their prices fall and vice versa. To earn profits from trading, bond prices must go up.
The current interest rate on liquid funds is roughly around 3-3.3 per cent which could go up to 4-4.5 per cent. Also, the target maturity funds could fetch somewhere between 6.4 and 6.6 per cent returns on target maturity funds maturing in 2026 or 2027. The tenure of target maturity funds is defined. Also, these funds passively invest in bonds of similar maturity. Though these funds come with no lock-in period, investors have lower chances of suffering from losses if held to maturity.
Considering the volatility of the market as of now and the low-interest rates one earns on fixed-income investments, investors can gradually park around 10 per cent of their earnings in credit risk funds now that bet on lower-rated corporate debt securities. Devang Shah, co-head, fixed income, Axis Mutual Fund added, “Credits remain an attractive play for investors with a 3-5-year investment horizon as an improving economic cycle and liquidity support assuage credit risk concerns, especially, in higher quality names.”