Clearly, in a scenario where there is no consensus on where interest rates are headed, retail investors need to stick to the safety-first principle. “Retail investors should anyway take risk in equity funds and seek safety and stability of returns from their debt-fund portfolio,” says Nikhil Banerjee, co-founder, Mintwalk.
Follow an allocation model:
Instead of thinking tactically, retail investors need to shift to an asset allocation model even while building their debt-fund portfolio. Choudhary suggests dividing the portfolio into three buckets: liquidity, core and satellite. The liquidity bucket should be for cash management. Invest in liquid and overnight funds here. The bulk of an investor’s fixed-income allocation, irrespective of the stage of the financial market cycle one is in, should be in the core bucket. "The defining feature of the core bucket should be that it should carry modest credit and duration risk," says Choudhary. Funds that invest in AAA and sovereign bonds with a maturity of up to four-five years would fall in this category. That would include money market to short- and medium-duration funds.
Finally, there is the satellite bucket. It can be higher on credit or duration risk but should form a residual or smaller part of the allocation. If an investor has the appetite, he may take some amount of duration or credit risk here by investing in an actively managed dynamic bond fund, which has proven its ability to consistently manage the interest-rate cycle over the past 10-15 years.
Investors could allocate around 10-15 per cent of their money in the liquidity bucket, 60 per cent in the core bucket, and 20 per cent in the satellite bucket.
Avoid duration and credit risk: With little certainty on where longer-term interest rates are headed, investors should avoid taking duration calls. Says Banerjee: “Only seasoned investors, who have a view on the macro economy, or have an advisor, should take duration calls. Most retail investors should stay away from longer-duration funds.” If yields on longer-duration bonds rise, they could end up incurring a loss in these funds.
On the credit side, the markets have witnessed a lot of dislocation over the past year-and-a-half. With the economy in slowdown mode, the credit scenario remains precarious. More incidents of credit defaults cannot be ruled out. Hence, this is not the time for investors to pursue high-yield strategies, like credit risk funds (that invest in lower-rated papers).
The safe zone:
Corporate bond spreads vis-à-vis government bonds are high currently. If liquidity sustains at high levels, yields on one- to three-year corporate bonds rated AAA and AA may even drop a little. “Invest in funds that target one- to three-year AAA and AA bonds. A person with a one-year horizon may opt for a low-duration fund while someone having a two- to three-year horizon may opt for a corporate bond fund,” says Dangi. The corporate bond fund should have a quality portfolio invested in AAA papers dominated by public-sector companies.
Take risk only at the margins: Opportunity beckons on the credit side. Several companies have withstood both tight liquidity conditions and the economic slowdown well. Their papers have stayed AA throughout this turbulent period. What is notable is that they have survived and not witnessed downgrades despite the difficult environment of the past few quarters. These are companies that have a dominant position in the market, are not laden with excessive debt, and also have management of decent quality. Dangi suggests opting for funds that invest in such papers. Typically, AAA papers in the PSU space having two- to three-year duration are trading at about 6.50-6.75 per cent. These AA papers are yielding 8.5-9 per cent, so investors can earn about two percentage points extra. They do come with some risk, however. Investors ready for it may go for dynamic bond funds trying to capture this opportunity.