Navigating Market Highs, JM Bond Inclusion; Should You Increase Fixed Income Portfolio Allocation?

As equity markets have surged to record levels, many investors are examining the need for portfolio reassessment. With Nifty 50 and BSE Sensex returning 22.5 per cent and 18.5 per cent respectively in the last year, investors are rethinking equity allocations and whether they should increase fixed income allocation at a market high. Of course, rebalancing portfolios is crucial to manage increased risk and volatility. However, the equity market reaching an all-time high is not a sufficient reason to increase fixed-income allocations. This rule doesn't apply uniformly. One should consider their risk profile, if their risk profile cannot afford to stay invested in equity for long for a rebound, then derisking should be done.

Venkatakrishnan Srinivasan, founder of Rockfort Fincap LLP, a financial advisory firm said, “A decrease in India's debt borrowing due to a lower fiscal deficit and inclusion in the JP Morgan bond index fund could create favourable conditions for fixed income investments. Lower borrowing may lead to lower interest rates, making existing bonds more attractive. Additionally, inclusion in the JP Morgan bond index may attract more foreign investment, increasing demand for Indian bonds.”

Conducive Factors For Fixed Income Allocation

High Interest rates:  Srinivasan said, “If the RBI adopts an accommodative stance and implements repo rate cuts, it could lead to lower interest rates. This scenario is generally positive for bond prices, as existing bonds with higher yields become more appealing in a lower-rate environment.”

In June 2022, the 10-year g-sec hit a closing high of 7.55 per cent, before tapering off. Currently, the Indian 10-year g-sec is in the 7.03 per cent and has stayed in 7 to 7.3 per cent almost throughout the last year. 

It could be a good time to lock in high accrual income by holding bonds until maturity now that interest rates have peaked. Adding higher duration to the portfolio looks attractive from a risk-reward perspective since investors will benefit from future rate cuts and can ride the yield curve down.

Inclusion in JP Morgan Bond Index: 

“Inclusion in JP Morgan Bond Index can attract more foreign investors, increasing demand for Indian bonds. This demand may drive up bond prices and lower yields, making existing bonds more valuable,” Srinivasan said.

Indian Government Bonds (IGBs) will be added to JP Morgan’s Government Bond Index-Emerging Markets (GBI-EM) index from June 2024 and continue till March 2025. The weightage of Indian bonds in the index will start at 1 per cent in June 2024 and will increase by 1 percentage point every month till March 2025 to 10 per cent weight in the bond index. A mere 10 per cent weight in the JP Morgan bond index is expected to bring inflows of about USD 20-30 billion.

Lower Fiscal Deficit: 

“A reduced fiscal deficit potentially leads to stability and increased confidence in the bond market,” Srinivasan said. In the interim budget, the Indian government targeted a lower fiscal deficit at 5.8 per cent for FY24 and 5.1 per cent for FY25, optimising market expectations. The lower fiscal deficit means reduced government borrowings and ease in government security yields. Thus private entities will be encouraged to raise capital through bonds. 

In addition, lower borrowings will increase the confidence of the external world that the Indian economy is in a more stable state, and more foreign investors will invest in Indian securities.

“While these factors create a favourable backdrop for fixed income, it's essential to consider potential risks, such as inflation, global economic conditions, and unforeseen events. Diversification and periodic portfolio reviews are key to managing risks effectively,” Srinivasan however cautioned.

However, market conditions are subject to change, and the effectiveness of your investment strategy depends on your specific financial goals, risk tolerance, and time horizon,” Srinivasan added.