How to make money amid rising interest rates? Here’s what Invesco MF’s Vikas Garg has to say

There is a paradigm shift in interest rates in the ongoing calendar year. The Reserve Bank of India (RBI) has upped repo rate by 140 basis points in response to the elevated inflation trajectory. There are hopes that policy rates may increase further by December 2022 before taking a pause. How the rising interest rates can impact debt market and how can investors benefit from rising interest rates? In an interaction with Business Today, Vikas Garg, Head of Fixed Income, Invesco Mutual Fund shared his views on the debt market amid rising interest rates. Edited excerpts:

BT: How has the year 2022 so far been for debt market investors?

Vikas Garg: Year 2022 is proving to be yet another year dominated by unprecedented events causing a heightened volatility across the global financial markets. While the year started on a positive note with many countries coming out of Covid-19 led disruptions on the back of a massive vaccination drive, it was sooner eclipsed by Russia-Ukraine conflict, which took everyone by surprise with significant surge in global commodity prices. Many developed countries have touched multi decade high inflation forcing the central banks to transition from a non-conventional ultra-lose monetary policies adopted in response to the Covid-19 led disruption to a more conventional-inflation targeting monetary policy and embark upon an aggressive rate hiking cycle. Consequently, global Interest rates have remained extremely volatile during the year with an upward bias as the market participants have struggled to gauge the inflation trajectory. Financial markets, especially the currency has turned even more volatile as the market forces are oscillating between inflation vs the recession fears in many developed countries.

There believe that RBI may increase repo rate by another 60 basis points by the December 2022. Debt investors have been adversely impacted with high mark to market hit as domestic interest rates have hardened sharply during the year with a flattening bias.    

BT: How fixed income investors can make money amid rising interest rates? Is it a good time to invest in debt funds? 

Vikas Garg: MPC has clearly articulated its concern on inflation which is reflected in retention of inflation forecasts at 6.70 per cent for FY23. Anchoring inflation trajectory remains a key priority for MPC and given the current inflation trajectory, we expect MPC to continue with front-loaded rate hikes and reach policy repo rate of 6 per cent by Dec 2022 / Feb 2023. Further rate hikes, if any, depend upon the expected inflation trajectory in FY24, which is still evolving and dependent upon geo-political uncertainty.

With challenging global backdrop as many central banks tightens the monetary policies to tame inflationary pressures, huge fiscal supply and RBI’s expected fast withdrawal of ultra-accommodative policy, we expect interest rates to remain volatile with an upward bias.  
    
Against the backdrop of many such uncertainties, we prefer using the conventional wisdom to contain interest rate risk with a moderate overall duration of the debt investment portfolio. Yield curve has already flattened sharply since January 2022 with 1-2 years segment hardening by around 180-200 bps while the 10 yr plus segment has hardened by much lesser 40-65 bps. A much flatter yield curve gives an opportunity to investors to cut down on duration risk and still continue to maintain high accrual.  

For investors looking at the core debt allocation over the medium term, the 2-to-4-year segment of the yield remains well placed from carry perspective as it has already priced in far more aggressive rate hikes. This segment is a sweet spot on the yield curve – neither too short which gets impacted by low gross yields, nor too long that can get impacted by the rate volatility. Actively managed fund in the categories like short term fund, corporate bond fund and banking & PSU fund will be able to keep high interest rate volatility under check while also capturing the upside potential once the interest rate peaks out by increasing duration.

Credit environment remains healthy; however, current narrow spreads of AA / AA+ over AAA bonds do not provide favorable risk adjusted reward opportunities, and we expect il-liquidity premium to increase sharply over a period of time thereby posing mark to market challenges for this segment.  

BT: How much weightage an investor can give to debt in their portfolio?

Vikas Garg: Fixed Income is a very important asset class and should be seen as a part of our core asset allocation just the way we look at the other asset classes like equity, gold, real estate etc. Statistically, looking at the volatility parameters, debt investments as a whole provide one of the least volatility in returns as compared to any other asset class. Debt investments also provide a low correlation with other asset classes, which can be beneficial in reducing the overall volatility of the portfolio. Debt investments play a very constructive role in aligning the portfolio volatility with the risk appetite of any investor and it also plays a complementary role in achieving specific financial goals. Prudent weightage of debt investment depends on everyone’s risk appetite on the financial assets which in turn can be guided by various factors like age, income, cash flow requirement etc.

BT: What are the things an investor should look into while investing in debt funds?

Vikas Garg: Investing in debt market is as easy or challenging as investing in the equity market. Both the markets encompass a top-down macro view supplemented with a bottom-up company selection approach. More specifically, one should follow a disciplined and a structured investment approach for debt investments by evaluating various macro indicators like growth – inflation & demand – supply dynamics that can have any bearing on interest rates. Longer the duration of debt funds, more could be the interest rate volatility and is more prudent for long term investment horizon. Selection of right credit and at an attractive valuation is very critical for overall debt portfolio construction. An investor should always assess fund’s overall risk profile as higher gross yield of the fund may also reflect higher & unacceptable credit risk.

BT: How can retail investors invest in bonds?

Vikas Garg: Retail investors can participate in bonds directly through the exchange houses. However, liquidity in such small lot can be very scarce. A better alternative can be to invest in bonds indirectly through the debt mutual funds. Debt mutual funds provide various products ranging from 1 day to 20 years maturity and can be used by the retail investors as per their portfolio allocation requirement. Investing in mutual funds has been becoming easier and more convenient with the rapid digital evolution. High credit quality- oriented short to medium term corporate bond funds, across different scheme categories have always provided an attractive investment opportunity to all the investor segments in terms of steady returns. Particularly for the retail investor class who generally have more than three-year investment horizon, Corporate bond funds offer relatively better returns on tax-adjusted basis as compared with a similar high quality bank fixed deposit.

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