While inflation pushes up the cost of living, it also brings opportunities in the debt market
One of the banes of the stimulus packages unleashed by economies across the globe has been the steep hike in inflation rates. In the case of the domestic economy, the issue has reached worrying levels with inflation having settled in a double-digit range. For an economy which is used to the figure in the range of 4-6 percent, the recent spike is a worrying factor.
While the Reserve Bank of India (RBI) has been steadily pushing investors to borrow less through rate hikes, the consumer apathy towards high prices has been a worrying factor too. A decade ago, high prices meant lower demand. In the case of a growing economy, demand is still chasing supply irrespective of the cost. The classic example has been the rise in vegetable prices. Onion prices came down not due to lower demand but due to government intervention in the form of crackdown on traders and import of onions.
While inflation may not be at alarming levels a few quarters down the line, the time has come for investors to keep a tab on this dynamic component of wealth management. While you need to look for products that are inflation-proof or help in beating inflation, you should also take the opportunities that come up in a high inflation regime.
The immediate fall-out of a high inflation era is that interest rates move up to push the consumers to reduce consumption and increase savings. If you are well-prepared or have liquidity in your portfolio, a debt allocation can prove handy. For instance, banks have been offering 9-9.25 percent interest on fixed deposits and mutual funds have launched fixed maturity plans (FMPs) with an indicative yield of 9.5-10 percent for 12-13 month tenures.
While the equity markets can deliver similar returns for similar tenures, it is not guaranteed or fixed. Even FMPs don't fix their returns, but you can expect to earn returns which are closer to indicative yields. More importantly, equity has the potential to offer less-than invested amounts which is not the case with debt instruments.
Another product that can come in handy when interest rates are peaking is the monthly income plan (MIP) of mutual funds. Though this product allocates a portion to equity and hence carries an element of risk, it can improve the overall portfolio returns if you invest when rates are peaking. Even in a falling interest regime, this product can boost returns because of yield dynamics. A word of caution for investors here - the product may not be suited for short-term investors and hence is recommended for 1-2 year horizons.
As is evident, while inflation brings its baggage of worries with high cost of living, it also gives an opportunity to invest in the non risk category. You can maximise your returns by getting your timing right and through new-age products such as dynamic price-to earning (PE) allocation, systematic transfer plan (STP) etc. While bank deposits and fixed deposits of companies carry lesser risk because of their fixed returns, mutual fund products score over them because of their tax advantage. Mutual fund debt products offer the benefits of indexation which can be an added advantage in a highinflation era. However, you should hold these investments for more than a year to claim the benefit as shortterm gains are taxed according to the income slab of the investor even in debt funds.
In line with the tide, mutual funds have been launching FMPs aggressively over the last quarter. Make the most of it while the going is good.
