Rising Interest Rate: What Should You Do
As the earning seasons are over now, all eyes are on the bi-monthly monetary policy committee (MPC) meeting of Reserve Bank of India (RBI) on Wednesday, June 6. In a run-up to this meeting, economists are equally divided on whether RBI will raise the interest rate or not. Nevertheless, we do expect RBI to raise repo rate, the rate at which the central bank infuses liquidity in the banking system, by 0.25 to 6.25 per cent.
We believe RBI will bite the bullet this time because for the month of April 2018, we saw headline core consumer price index (CPI) increased unexpectedly to 4.6 per cent against the median expectation of 4.4 per cent. Besides, crude oil prices are surging and have touched US$ 80 per barrel recently before cooling off. Another important factor that is favouring a rate hike in India is a likely rate hike by US Fed Reserve.
If that is the case, how should you position the debt part of your portfolio? The rising interest rate has different implications on different types of debt funds. There are many types of debt funds, such as liquid funds, ultra-short-term funds, short-term funds, gilt funds, long-term funds, income funds, and dynamic bond funds. What differentiates these funds are the type of instruments they hold, they contain bonds whose issuers may be the central or state government, or a public or private corporate of different duration. Therefore, a short-term fund might be holding bonds with shorter maturity while a long-term fund might be holding long-term government securities. As interest rate rises, it greatly impacts funds having more long-term debts such as G-Secs. There is an inverse relationship between rising interest rate and long duration bonds. Therefore, we have witnessed in the last few months as yield has moved up long-term debt funds have given negative returns. Nonetheless, not all the debt funds have given negative returns, there are some funds especially who invest in shorter maturity instruments are generating better returns.
Therefore, investors should exit the long-term debt funds and enter the short-term debt funds as it is going to generate better returns going forward.