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Investing in debt instruments

Here is the analyses of potential of various debt instruments this year





   As the global economy slowly pushes itself out of recession with the help of extensive stimulus programmes and records an impressive growth, the process of normalisation of key policy rates and gradual withdrawal of the stimulus can be expected during the year. Some countries such as Australia have already raised the key policy rates and others are expected to follow suit in 2010. The emerging markets such as India, China and Canada can be expected to hike rates in the first half of the calendar year. 

   The domestic economy grew at an impressive 7.9 percent in the second quarter backed by huge government spending and improvement in consumption and investments. The downer, however, has been the inflation numbers which have been rising steadily on account of increases in prices of food products. The annual Whole Price Index (WPI) inflation which stood at 1.34 percent in October rose to 4.78 percent in November, and it is expected to rise up further this fiscal. 

   In order to control inflation, there will be some tightening of key policy rates and a gradual exit from the easy monetary policy by the Reserve Bank of India (RBI). It is likely that the RBI will hike the cash reserve ratio (CRR) - funds to be kept by banks with the RBI - in order to curtail liquidity in the market. The expectation of a rate hike has already led to the hardening of bond yields. This is showing in the negative returns of gilt funds and long-term income funds. 

   For an average investor in debt, the popular debt investments are bank fixed deposits (FDs), small savings instruments, corporate fixed deposits and debt mutual funds. 

   It is advisable to not enter into FDs with longer maturities at this stage since banks are expected to raise the deposit rates in line with the monetary policy changes. Some banks have already started raising the deposit rates in order to attract investors. A slew of corporate fixed deposits are currently available in the market. Investors need to check the rating of these companies as also their reputation the market since high interest being offered is to compensate for the higher risk that these instruments carry as compared to bank FDs. 

   Debt mutual funds invest in debt instruments such as corporate bonds, government securities and money market instruments through income funds, gilt funds and liquid funds, or may have a small exposure to equity as in monthly income plans. As regards debt mutual funds, investors would do well to stick to funds having securities with shorter maturities such as short-term debt funds, and liquid and liquid plus funds. 

   Income funds and longterm gilt funds with relatively longer maturities should be avoided at this stage. The short to medium-term future of these would depend upon the policy stance of the RBI. Hence, a call on these funds can be taken once the monetary policy is out of the way and there is more clarity on interest rate movements. Hence, short-term funds with a maturity of 3-6 months would be safer bets in the current scenario. Floating rate funds and actively-managed debt funds which are quick to align to interest rate movements could be considered for investments. 

   For investors with a low risk appetite, hybrid products which combine debt and equity may offer a good investment opportunity. A monthly income plan of a mutual fund is one such product which invests 10-30 percent of the corpus in equity while the balance remains in debt. With equity markets set to remain buoyant, these products may bring better returns for investors at a relatively low risk appetite. 

   No changes are expected in the small savings instruments such as post office schemes, PPF, NSC etc. The Direct Tax Code which is expected to be implemented in year 2011 may bring about some changes which could affect these. However, these changes are not expected this year.

 


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