Where to invest is a hot topic of discussion
everywhere after stable government is formed at the centre. Everybody talks of
economy doing better in coming years as faster decisions are likely as new
government has committed itself to lowering inflation and focusing on economic
growth. RBI in its first policy review after new government took charge kept
key rates unchanged clearly indicating inflation needs to be addressed first.
Unless inflation comes under control and fiscal deficit reduces, RBI is
unlikely to reduce the key rates and unless there is rate cut interest rates
are unlikely to soften. Its known fact that high rate of interest are hurdle to
economic growth as borrowing become costlier. Corporate world is also eagerly
waiting for rate cut so that they can expedite the new projects and increase
the supply side.
The problems are part of life and are likely to
remain in one or other form, but the important thing is most of the experts are
positive and nobody doubts the capabilities of the new government. Most of the
experts are bullish on equity market but before taking investment decision we
also have to see risk reward ratio. The Nifty has already rallied around 50%
from the bottom of 5100 to 7500 in nine months in a scenario when our GDP is
growth is below 5%. It’s true that market discounts the future and the rally is
for the faster change and hope for the future. The debt market on the other
hand is range bound after last repo rate hiked in January this year. The
current repo rate is at 8%. The all time repo rate high was 9% in July’2008 and
all time low was 4.75% in April’2009. Looking at the current scenario I think
that risk reward ratio is in favour of long term debt and gilt funds.
Most of the economists and experts believe that the
growth is likely to peak up in coming years then there is earthly reason to
believe that interest rate will come down. This will not happen immediately but
may take few quarters. The common investors do not know how the debt funds work
and how the change in interest rate affect the performance of the debt funds .People
needs to be educated about the option available in the market beside
traditional instruments. If your time horizon is 2 to 3 years and can bear
short term shocks of inflation, debt funds are good bet as of now. If I have to
choose between equity and debt, surely I will punt on debt funds knowing the
downside risk is low. Debt funds of mutual fund always give better returns when
interest rates fall and also has added tax advantage because of indexation
benefit which reduces your tax liability if you hold debt funds for more than
12 months.
Let us understand how the debt fund works by taking
an example. Suppose Company “A” issues a bond today for 10 years and the price
of one bond is Rs. 1,000 with a rate of interest i.e. coupon rate of 10% p.a. The
bond is also listed on the exchange. One investor say Mr. X buys 10 bonds by
investing Rs. 10,000 in the company. He is likely to get interest of Rs. 1,000
every year as promised by the company. If the rate of interest drops by 2% to
8% p.a. in next two years then the price of the bond will increase from Rs.
1,000 to 1,115. Mr. X is now making a profit on the bond price and he can sell
the bond in the market and book profit plus has also earned interest of Rs.
1,000 for two years. The return on his investment is around 15% p.a., subject
to long term capital gain but still much higher than traditional instruments
like fixed deposits and postal schemes.
The major reason why debt funds are not popular is
that they are market related and returns are not guaranteed like fixed deposit
and postal schemes. Further any extra pressure on inflation due to internal or
external factor can change the interest rate scenario and give negative return.
With the stable government at centre and inflation under control rate hike is
unlikely and thus indicates very limited downside risk. If you do not want to
take credit risk than gilt funds are ideal as it invests in Government of India
bonds which enjoy highest safety in Indian markets. By investing in gilt funds
you only run interest rate risk. It is advisable to invest in growth option
compared to dividend option as there is high dividend distribution tax on debt
funds which reduces your overall return. If you really think “Aache Din
Aanewale Hain” then the possibility of higher return with moderate risk is
possible by investing in long term debt and gilt funds.
