Prashant Patil is a mechanical engineer. For the past two years, he has been investing in mutual funds. Being a conservative investor, he populated his portfolio mainly with debt funds. This strategy earned him decent returns while the risks remained minimal. However, in the past few weeks, investing experts on the news channels have been advising investors to shift to short term funds. This has been a cause for concern as Prashant has a lot of money invested in long-term debt funds.
Prashant is not sure whether to stick to his original strategy or shift his wealth to short-term funds. If you are investing in the current climate, you may be in the same situation. In such a case, it may be a good idea to invest in short-term duration funds.
Here are the reasons why moving to short-duration funds can be good for you.
Reasons for change in strategy
Analysts and investors across the country expected the Reserve Bank of India (RBI) to announce a rate cut during the fifth bi-monthly policy review that was held on 7th December.
However, the RBI’s decision to leave the repo rate unchanged left many shocked. In addition, the US Fed announced an increase in rates by 25 basis points.
These two news items have caused a tectonic shift in investment strategy. Analysts who have been advocating investments in long-term funds have now changed their tune.
Considering the delay in rate cuts by the RBI, analysts recommend investors to hold two-thirds of their portfolios in short-term products. As for the remaining third, they consider dynamic bond funds to be the best bet at the moment.
Impact of demonetisation
Post the demonetisation drive by the government, the liquidity in banks has increased by a great deal. The market witnessed a sharp rise in buying of bonds due to sluggish credit growth in the country. Due to this, the benchmark bond yield decreased by as much as 60 basis points from 6.8% to 6.2% within a fortnight of demonetisation, according to a report by Business Line.
Long term debt funds depend a lot on rise in prices of government bonds to achieve capital gains. This can be a problem if prices go down.
Global impact on rates
While India has been adjusting to demonetisation, the waves on international shores haven’t been calm either. The hike in Fed rates following close on the heels of Brexit and the US elections could continue to impact the volatility of bond markets. As the uncertainty continues, experts believe that the RBI will act upon rate cuts when global markets stabilise.
So where should you invest?
Ideally, short-term volatility shouldn’t be the deciding factor for mutual fund investors. But if you have already invested heavily in long-term funds, it is better to transfer a portion of your wealth to short-term funds.
In the current economic scenario, the best option is to invest in ultra-short term bonds. The other option you should consider is short term debt funds. Unlike long-term schemes, they are less volatile since it’s held until maturity. Hence, uncertainties in the global markets will not impact your gains.
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