Inflation, Interest Rate and Debt Portfolio

Objects in the mirror are closer than they appear’ is a safety warning that you normally see printed on the passenger side of mirrors. This warning has implications even in the investment world. What you expect to be delayed may arrive earlier. For instance, Reserve Bank of India till now has maintained an accommodative stance and has not given any indication of a rate hike in near future. Nevertheless, the way the monetary policy landscape is changing elsewhere, we may see the RBI changing its stance sooner than later. 

Recently, US Federal Reserve increased its benchmark interest rate, the first time in three years. Similarly, Bank of England raised interest rates for the third consecutive time. To make things complicated, the invasion of Ukraine by Russia has sent energy prices surging, which will further put upward pressure on inflation. The latest inflation number shows it is already running ahead of RBI’s comfort zone. So, we may see early interest rate hikes even in India. Though the equity portion of your portfolio will also get impacted by a rise in interest rate, it is the debt part of your portfolio which will have a direct and relatively higher impact.

Hence, you need to evaluate the role of debt funds in your portfolio and focus on allocating to funds whose NAVs will be less volatile to interest rate risk. Historically, we have seen that the longer end of the duration curve has not generated better returns in a rising interest rate scenario and they carry higher risk. For those who wish to invest in long-term debt, dynamic bond funds can be a suitable option against investing in standalone long-term debt MF categories. My advice will be to invest in categories that invest at the short to medium end of the duration curve.

 SHASHIKANT