It’s Time To Add Debt In Your Portfolio And Practice Asset Allocation

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It’s Time To Add Debt In Your Portfolio And Practice Asset Allocation
It is important to include debt in your portfolio as they provide a cushion in the event of a sharp fall, and proper asset allocation is the smart way to do that
I Thabresh & Deepak Singhal - 31 October 2022

Globally, several of the advanced economies is going through a tough phase with inflation being at multi-decadal high and fears of an impending recession ratting the financial markets. Already, several of the central bankers have tightened interest rates to curb inflation and India is no exception. Thus far this financial year, the Reserve Bank of India (RBI) has increased rates by nearly 150 basis points while a further hike of 50 bps cannot be ruled out. At such a juncture, as an investor it is time to take necessary actions to keep your investment on track.

There are expectations that equities are likely to remain volatile in the near to medium term with a downward bias. Therefore, a portfolio highly concentrated in equity-related instruments may not be a prudent choice at the current juncture. So, it is time to balance out your investment and practice the evergreen asset allocation strategy - a key to successful investment. While at it add debt instruments in your portfolio.

Often, debt as an asset category is misunderstood to offer returns lesser than inflation. This may not be true at all times. In fact, debt investments have an important role to play in a portfolio as it provides a cushion to the overall portfolio from sharp drawdowns. Further, it is a misconception that debt mutual funds do well only during the low interest rate scenario. Given the innovation in debt products, investors have the option to choose from a variety of debt schemes as per the risk appetite and financial goals to create wealth in the various cycles of interest rates.

Economic indicators suggest that India is currently in the growth phase of the economic cycle. Typically, in this phase, credit spreads tend to widen which makes accruals attractive. And in a monetary policy tightening phase, portfolio durations are actively managed which benefit investors. It is worth noting that a rising interest rate scenario favours investments in floating rate bonds as the spread over 6-month T-bill is attractive and would get further adjusted with rising yields. In floating rate bonds, the coupon is not static but moves up as interest rates head higher. So, the income from coupons keeps rising and since the coupon keeps adjusting, the capital value does not reduce. Rising rates are also conducive for the performance of fixed income among various asset classes.

Investors may consider adding following debt funds in their portfolios as part of asset allocation.

Short-Term Debt Fund: For your short-term investment needs, a short term debt fund can be an optimal investment solution, especially given the rising interest rate scenario.

Accrual Fund: Accrual investment strategy is essentially holding the paper (bonds) till maturity and benefiting from coupon payment. Debt funds which follow such a strategy considerably reduces the risk emanating from interest rate cycles, especially in a rising interest rate scenario. It would be preferable to choose funds which follow a buy and hold approach as these are suitable options in a rising interest rate situation. While investing in such a fund, investors should stay invested till the maturity of the papers in order to enjoy optimum returns.

Target Maturity Funds: These are primarily passive debt funds which track an underlying bond index. Such funds aim to help investors navigate the risks associated with debt funds by aligning their portfolios with the maturity date of the fund. Since they track the bond index, such funds tend to have portfolios comprising securities, which are part of the underlying bond index, and thus have maturities in line with the fund’s stated maturity. All these bonds or securities in the fund’s portfolios are held to maturity. This ensures that the duration of the fund keeps reducing with every passing year and thus investments are less prone to price fluctuations caused by interest rate changes.

Credit Risk Fund: If you are a savvy investor, credit as an asset class looks promising. It is likely that in the next 1-2 quarters, the valuations would turn very attractive. So, it is a good time for retail investors to get into credit risk fund.

To conclude, it is time to strictly adhere to asset allocation and make an allocation to debt if not already done.

The views are personal and are not part of the Outlook Money editorial Feature

I Thabresh & Deepak Singhal, Partners, Infinity Money Mart

Infinity Money Mart is a boutique investment firm based out of Chennai catering to clients globally. The firm caters to HNI investors with focus on better risk adjusted return. The team consists of Certified Financial planners and ex Private bankers who have 15+ years’ experience of working with large MNC and Private wealth firms.

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