Some helpful investment tips

Since some time now, mutual funds have become synonymous with equity schemes. Hardly anyone has looked at debt in the recent past. Even if debt exposure is sought, it is through balanced schemes. Or liquid funds or floating rate funds are used as a temporary parking place for cash. However, things are changing.

Everyone knows that interest rates have been rising. On the borrowing side, home loan buyers are already paying almost two per cent more. On the investing side too, eight per cent is being offered on a one-year deposit. Could anyone have had imagined this six months back? Which is why they say, when it comes to forecasting interest rates, either predict a date or a rate but never both.

Will this rise in interest rates be secular? In other words, will rates continue to rise or at least be maintained at this level? Or will they fall back again? I repeat once again --- Either predict a date or a rate, never both.

Just like stock prices, interest rates too will rise and fall; however, no one can say which will happen when. Increasingly we live in a volatile climate --- both locally as well as globally. Geopolitical tensions, commodity prices particularly that of oil, the consequent impact on inflation, trade flows, government policies, the threat of terrorism --- all these factors and more ultimately combine to impact rates and therefore an accurate prediction is almost an impossibility.

However, what we do know is that at least in the near future (short-term), interest rates have climbed. An 8.5 per cent to 9 per cent return on short-term debt is definitely possible. The uncertainty prevailing amongst market players can be clearly gauged from the fact that currently the return on even long-term fixed income paper is not much different. (The 10-year government bond yield is going at 8.20 per cent). Normally, there should be a premium for committing your funds for a longer period of time.

Be that as it may, it is indeed possible for investors to avail of the aforementioned rates for little or no risk at all. However, the choice of fund is important. Remember that this is not true for all income schemes available in the market. The average one-year return on most income schemes is still a paltry 4-5 per cent p.a. This happens on account of the fact that existing income schemes are saddled with already invested paper languishing at lower rates. When the current rates in the economy start to climb, this existing low yield paper has to be sold at a discount thereby lowering the NAV and the return on investment.

Interest rates and prices of fixed income instruments share an inverse relationship. In other words, when the overall interest rates in the economy rise, the prices of fixed income earning instruments fall and vice versa. This is called the interest rate risk and adjusting the portfolio to the market rate of return is 'Marking to Market'.

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Tags: mutual funds, equity schemes, debt funds, balanced schemes, interest rates, investment, stocks, volatile, short term debt, NAV, returns, fixed income, economy, market