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Debt Instrument: Safer option in turbulent times equity for capital preservation

The macroeconomic factors world-wide have been quite shaky over the last couple of quarters. As a result, the stock markets have been quite volatile with a negative bias all over the world. In line with market conditions, the performance of equity based instruments remained quite subdued. As uncertainty prevails in stock markets, investors are not keen on putting their money in equity-based instruments.

The meltdown in the equity markets started with the slowdown in some countries. This coupled with several other negative developments like a sharp rise and fall in commodity prices (crude oil, metals, food items etc), fall in the global inflation rate and meltdown of some of the large financial houses kept triggering negative sentiments in the markets.

Analysts believe the negative sentiments will continue in the stock markets for a few more quarters, and therefore, the stock markets will remain volatile in the medium term. Therefore, it will be risky to invest in equity-based instruments. Investors with a low risk appetite should reduce their equity exposure and allocate a larger portion of their investment basket to debt instruments, which offer attractive returns in the current high interest rate situation. Debt instruments include corporate debt, liquid/liquid plus funds, debt mutual funds, bank deposits, public provident fund etc. The main objective of debt funds is preservation of principal with modest returns in the form of interest or dividend.

These are some factors investors should consider while choosing debt instruments:

A) Objective

The investment objective could vary from short-term parking of funds and waiting for investment opportunities, to investing in low risk long-term funds for capital preservation. It is important to analyse the objective as it helps in selecting the right investment instrument.

B) Time frame

A timeframe in mind helps choose the right investment instrument. There are instruments with a longer timeframe and give decent returns with less flexibility in terms of liquidity. On the other hand, there are funds with a lot of liquidity but yield lesser returns.

There are various types of debt instruments available in the market:

  • Debt mutual fund

Debt mutual funds include instruments like corporate debt, liquid funds, debt funds etc. The main objective of a debt fund is the preservation of principal, accompanied by modest returns. Liquid and liquid plus funds are attracting foreign investors, domestic funds as well as high net worth individuals. Liquid funds are used to park money for a short term. They provide high flexibility. Many institutional investors have been investing in debt funds here due to the vast difference between domestic and overseas interest rates.

  • Bank deposit

Banks have increased the rate of interest on their fixed deposits to attract funds in these tight monetary conditions. Many banks are offering 10-10.5 percent on 1-2 years' maturity fixed deposits. Bank deposits are also good for short-term investors (less than three months) who generally keep their money in the savings account.

A short-term bank fixed deposit provides 6-7 percent returns. Nowadays, many banks provide funds sweep-in/sweep-out facility where a balance beyond a certain limit automatically gets converted into a fixed deposit and the bank pays a much higher interest rate than the normal savings account interest rate.

  • Commodities

Investments in gold and silver (or gold exchange traded fund) is another attractive option for debt investors. Investments in commodities have yielded good returns over the last few quarters and analysts believe that more funds are pouring into the commodities market due to the negative sentiments prevailing in the equity markets.

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