Investors come to fixed income mainly for two reasons: One, this is the only product where you can park your surpluses without any worry. If you are bearish on equity or real estate or commodities or you are waiting for correction in those markets or you are looking to invest on a systematic basis over a period of time, fixed income is the ideal vehicle to park your temporary surplus. The second reason, of course, is safety.
In 2010, both these reasons will hold true. With equity markets running a tad above their fair value, you can park your funds in fixed income and re-enter the equities after a correction. You would also want to protect your capital from the surrounding uncertainty.
Let us look at the interest rate outlook for this year. It is tough to take a call for all the next 12 months right now, because much will depend on the government’s borrowing programme. If the budget unveils a borrowing plan far exceeding the market expectation, the interest rates will certainly rise. On the
other hand, if it is lower than expectations, the rates will come down significantly. Non-food credit growth has been low in 2009 because falling commodity prices reduced the need for working capital and companies took a pause in project execution. But the hope is that in 2010-11, non-food credit will pick up. Commodity prices have gone up and this will increase the need for working capital. Also, companies may resume their spending on the project side. In this scenario, my advice to investors is to first move into ultra short-term and short-term bonds which will give a lesser volatile return in a rising interest rate cycle, which is what we are witnessing now.
And then, take a call on whether you should move into income funds or not. Look at the budget and the other asset classes to make this decision. In particular, fixed income has the potential to become the flavour in the second half of 2010, when inflation could be high, borrowing would have picked up and interest rates would have risen.
Fixed deposits are the most popular fixed income product. There is no peer group that can rival bank deposits in their spread and reach. However, history suggests that income funds and bond funds have outperformed bank fixed deposits. This will continue.
My recommendation to retail investors is this: don’t try to put your money in corporate bonds directly. You will lose out on the benefit of diversification. Mutual funds will give you exposure to 50 companies even if your investment is just Rs. 1,000. This diversification of risk is far more crucial than getting a 0.5 percent or 1 percent extra return. Remember, there is no free lunch. Don’t take too much risk for too little extra return. However, high net-worth individuals and informed investors can look at direct investment in bonds.
One final point: If you have given a certain weight to fixed income in your asset allocation, I don’t think there will be a need to increase that. If you ask me if fixed income is going to become more attractive than other asset classes, the answer is no. Surely equities and commodities have the potential to outperform fixed income in 2010. You don’t need to be overweight on fixed income. (As told to Pravin Palande and S. Srinivasan)
(This story appears in the 22 January, 2010 issue of Forbes India. You can buy our tablet version from Magzter.com. To visit our Archives, click here.)