Tips To Manage Your Debt Portfolio

The RBI, in its third quarter review of monetary policy on January 28, 2014, unexpectedly raised the repo rate by 25 basis points from 7.75 per cent to 8.0 per cent. Besides, the reverse repo stands adjusted at 7.0 per cent and the Marginal Standing Facility (MSF) rate and the bank rate at 9 per cent.  

Repo rate is the rate at which the central bank lends money to banks. The reverse repo rate is the rate at which the RBI borrows from banks. However, the central bank decided to keep the cash reserve ratio unchanged at 4.0 per cent of net demand and time liability.  

The move caught the market off-guard as in its mid-Quarter Review on December 18, 2013 the RBI decided to wait for more data before acting. However, despite a substantial fall in food prices, especially of vegetables, the central bank opted for tightening this time around. The RBI attributed its action to the fact that CPI inflation excluding food and fuel remained flat and WPI inflation, excluding food and fuel, rose after mid-Quarter Review.  

It is quite evident from RBI’s move that its focus has currently shifted from moderating economic growth to inflation management. Moreover, the monetary policy review also indicated a shift in the RBI’s focus from WPI-based inflation to CPI-based inflation, as recommended by Dr Urjit Patel Committee. The Urjit Patel Committee also indicated a ‘glide path’ for disinflation that sets an objective of below 8 per cent CPI inflation by January 2015 and below 6 per cent CPI inflation by January 2016. The Reserve Bank’s baseline projections set out in the accompanying review of Macroeconomic and Monetary Developments for Q3 of 2013-14 indicates that over the resulting 12-month horizon, and with the current policy stance, there are upside risks to the central forecast of 8 per cent. 

The unexpected rate hike negatively impacted the debt market. The benchmark 10-year bond yield rose by 9 basis points following the hike. The RBI’s decision to hike the repo rate has created a dilemma in the minds of existing income fund investors about what to do with duration based and dynamically managed bond funds in their portfolios. These categories of funds have been facing frequent bouts of volatilities since the time the RBI hiked MSF rate last year. Consequently, short term returns from these funds have been poor.  

However, it would be prudent for investors not to panic and make a well informed decision. Before making any decision, they must consider RBI’s hint of no further rate hike in near term, if CPI eases as per its projections. It is equally important to know that the central bank may not cut rates anytime soon. Another important factor to understand is that, dynamically managed income funds actively manage interest rate seasonality. This strategy alone contributes to bulk of their returns. Therefore, there is no reason to believe that these funds will not be able to do so going forward. Besides, the repo rate hike will provide support to Rupee in case the US Fed opts for sharper QE tapering. Hence, if one still has a time horizon of 15-18 months and the allocation to these funds is not very significant vis-à-vis their debt fund portfolio size, it would be prudent to remain invested in them.  

For investors looking to invest in income funds at present, there are a few attractive opportunities. For those who can lock-in money for a fixed period, Fixed Maturity Plans (FMPs) would be ideal. Not only investors can benefit from higher yields but also the returns would be more tax efficient than traditional options like FDs. However, if one intends to maintain liquidity while investing with a time horizon of 18- 24 months, there are open-ended funds such as short term income and accrual based income funds. 

Similarly, if the objective is to park money for a few weeks or months, liquid and ultra-short term income funds respectively continue to be good options. However, the key here is to select the right option. For investors who are liable to pay taxes at the rate of 10 or 20 per cent, assuming that investments are made for a couple of weeks or months, growth option would be ideal. For investors in the highest tax bracket of 30 per cent, daily dividend re-investment option would be better as dividend distribution tax (DDT) is around 28 per cent and short term capital would be taxed at nominal tax rate. 

Hemant Rustagi
CEO, Wiseinvest Advisors