Central banking often spells bad news for the stiff upper lip. This time it was no different. The regulator, which suddenly rejigged its policy in favour of a higher repo rate, has prompted a two-fold change on the debt front. Deposits now fetch more, while borrowing costs have escalated. And that is just the surface—the classic depositor-borrower binary stands upended just as the debt fund investor is upset. It is time for the latter to alter his investment style in sync with the emerging situation.

The debt market, which has already witnessed a round of uncertainty, is now expected to trigger newer investment strategies. Professional intermediaries have encouraged clients to adopt a cautious view insofar as fresh allocations are concerned. They are being particularly urged not to consider longer-term investments at this stage. Instead, short-term debt is currently the most recommended option. For those who are willing to approach the market through debt funds are being told to consider low-duration and short-term products. These stand a better chance in view of the impending risks associated with longer-term investment ideas, it is believed. The opinion of experts is simple: this is the time to focus on defensive strategies.

How should investors behave at this juncture? How will the measures that Reserve Bank of India (RBI) has already taken and those that are impending in June, impact their existing investments? Is there any way of gaining from the apex bank’s unscheduled announcement and similar moves that the market now anticipates will come sooner than before? While you may read the last question in the context of the latest inflationary figures (Wholesale Price Index-based inflation was at 15 per cent or so in April), here is a triad of strategies to consider.

• Recast your debt holdings
• Go short and shun long if you want fresh allocations
• Seek higher yield if you want to stay put

There is a case for an overhaul of traditional debt portfolios. The latter may be altered to accommodate riskier but potentially more rewarding asset classes. This is because pure debt-based holdings are not expected to fetch much in the days ahead. The average investor is also being urged to explore short-term options instead of longer-duration plays. The latter will not amount to much in a scenario where rates keep changing rapidly. It will only add to the investor’s risk. Investors must remember that staying longer in debt implies greater interest rate risk.

Of course, if risk is not a serious consideration, a major drive towards sharper yields can be initiated. However, selecting high-yielding securities and moving out from orthodox, low-yielding ones may add to your expenses. This is a formidable issue for investors everywhere. Further, such tactics may not be fully tax efficient—and taxation is another vital matter for all quarters.?

Bond, Not Bondage

If you are indeed a brave-heart and do not mind the risk (or the tax), this may be an opportunity for you to look at direct investments. In other words, the time to consciously move away from debt funds (that is, take the indirect route) is here. As a direct investor, you will need to select a number of listed securities and allocate on your own. This will require both expertise and time.

Assuming that you have both to spare, you may proceed with the exercise. A list of liquid securities (which generate enough trading interest) may be drawn up as a primary measure. There is a formidable cautionary angle too: do not indulge in trading if you do not feel up to it. Trading directly can be a volatile exercise, and countless embittered investors can vouchsafe this on the basis of their own experience. Professional managers take the burden off your shoulders; this is among the principal reasons why even seasoned players often prefer funds.

Be that as it may, direct participants in the debt market will have other considerations to explore. These include yield to call and yield to maturity—both are critical metrics for investors. Credit ratings are significant factors as well. A favourable rating will surely weigh more in certain cases. An unfavourable one will paint a dark picture in comparison.

Moreover, an issuer company’s past behaviour is considered important. Has the company defaulted in servicing investors? Has it paid interest and repaid principal in a timely manner? How has the credit rating changed over time? These are some of the most relevant questions that have to be asked.

A key element to note is that the average ticket size is not considered “investor-friendly” in the bond market. A high minimum investment criterion will not find favour with ordinary investors. On the contrary, a normal open-end debt fund can be purchased for a very low sum. For systematic investment plans, the minimum ticket is even lower. That is what makes funds the most affordable alternative. For the aam aadmi, it is the most appropriate path to take.

Core, The Buzzword

Whether you actually overhaul your position or not, the new dynamics in the debt market make it imperative to form a core strategy. And target maturity schemes (TMS) can constitute an essential part of it. TMS can be a good fit for the slightly conservative investor who wishes to avoid probable cost and tax implications. Their likely performance (here the fund managers usually hold their securities till maturity) is worth noting.

Now, many participants will still want to have fixed deposits as their core holding. For them, the tactic to adopt is fairly uncomplicated. This is the time to move towards higher interest rate-bearing instruments. Such a measure will help them make fuller use of the effect of RBI’s policy too. The fact is that deposit rates have lately inched upwards. A number of banks and finance companies have already announced new rates.

The central question with regard to the core has also come into play. Will you invest more in fixed interest-bearing options or choose variable returns delivered by an actively-managed debt portfolio? Remember, when rates are likely to accelerate further, it makes little sense to lock into longer-tenure deposit. A fixed deposit that yields, say, 7 per cent today will turn unpopular when rates of competing deposits go higher. A regular bond fund is unlikely to furnish more than the average fixed deposit at the moment. Ergo, the issue of allocation—how much for which category?—has to be dissected with a fine scalpel.

Let me draw the curtains by quickly referring to what is now clearly a secondary matter, the method of allocation of your surplus. Should a gradual investment programme be followed? Or should you invest in bulk and wait for tailwinds to appear on the horizon? For the moment, finding an accurate answer poses a real challenge. The banking regulator will certainly follow a pragmatic policy in view of the hardening inflationary trends.

In this context, remember a few common codes:

• The general idea is to make the most of the emerging situation in a planned manner. A sudden and aggressive switch may not be the strategy to adopt if you are moving from one end of the risk spectrum to another.
• Whatever changes are being done must be in keeping with one’s risk profile. All alterations must be made within the confines of exact risk-reward parameters
• Whatever method you choose to follow, the final arbiter is inflation-adjusted return. If the latter appears a decent statistic on the horizon, you will feel its favourable impact. Else, it will be a clear case of under-performance.

The author is Director, Wishlist Capital