As the global financial crisis cuts a notch deeper and many economies officially go into recession, stock markets have turned quite choppy. Liquidity is significantly tight at this point, interest rates are on a generic basis cooling off. Business confidence is glum, job-cuts have become the order of the day. It is pertinent now to evaluate some alternative investment avenues to suit the current scenario.
Income and Gilt Funds Income funds invest in corporate bonds, government securities, PSU Bonds and, to some extent, in Commercial papers and Certificate of Deposit.
The maturity period of the underlying assets could vary between 0.6 years and 3/5 years depending on interest rates scenario. Unlike Income funds, Gilt funds invest in government securities. The average maturity period for Gilt funds is around 5.5 years – 16.5 years, depending on whether it is a short/ medium/long-term fund.
Falling interest rates are favourable to income/gilt funds, there exists an inverse relation between interest rates and bond prices. Bond prices go up when interest rates move southwards, this, in turn, reflects in capital appreciation, whereby the returns from income/gilt funds turn out to be attractive.
Here is a simple example to understand the dynamics of bond prices and interest rates. Let us assume that the interest rate was 10 per cent and given a cooling interest rate scenario, the interest rate has fallen to 9 per cent in the market.
The bond with a coupon of 10 per cent on a face value of Rs 100 will continue to earn the same interest even when interest rates in the market fall down.
Thus, the demand for bond paying 10 per cent coupon will go up in the market and the price of the bond will increase such that the new investor gets 9 per cent on market value, on the day the new investor purchases the bond. The reverse situation holds good when the interest rates are peaking and income funds can generate negative returns in such periods. Hence, one could use income funds for a part of one’s overall debt investments.
Outlook: Though returns have been very good in gilt funds, there could be limited upside left from hereon. However, income funds could have some steam left. Corporate spreads are key indicators whilst deciding the entry and exit points of income funds. Corporate spread refers to the difference between yields of corporate bonds and equivalent Government Bonds.
There is speculation that there would be further rate cuts with the impending elections. Due to base effect (sudden spike in interest rates last year), there could be further downside in inflation rates, and this will, in turn, ease the liquidity.
One more round of rate cuts is anticipated, which will help the income funds to perform well. That would make income funds a good investment with a 12-24-month perspective. Income funds also have the flexibility of altering their maturity periods, hence narrowing of corporate spreads could see income funds investing in bonds with higher maturity, thereby locking into higher interest rates.
Gold With the financial markets remaining chaotic, gold is considered a safe haven. This asset class is likely to provide a balance if your portfolio has a large capital market exposure. Historical evidence shows that bullion moves in negative correlation with equities.
Outlook While from a demand perspective, one could see lower demand as gold prices skyrocket demand may continue to hold steady for gold as an investment option. One could consider investment in gold in the form of ETFs; one can also consider investment in Gold Mining Funds.
This will give better liquidity, will lower the risk of holding physical gold and reduces transaction costs (transaction charges levied by banks, wastage and making charges, and storage costs). One can allocate about 5-10 per cent of one’s portfolio to Gold. However, considering that gold has run up recently, it maybe a good idea to phase out your investments and not invest a lumpsum at a single time.
While central banks are likely to increasingly use gold for their reserves in the long term due to high volatility in currencies, in the short term, some central banks could sell their gold holdings as a means to fund their debt repayments. Gold is suggested for a time frame of one-three years.
Keep scouting Consistent scouting for investment avenues is the rule to ensure that you are dwelling with the best in your portfolio. We have outlined just two such options in this article.
There are other avenues, such as fixed deposits including in banks and public sector financial institutions.
