Monetary policy review announced last week by the Reserve Bank of India (RBI) provided a somewhat hawkish undertone with shifting of the policy stance from accommodative to neutralThis resulted in a fresh spike in the 10-year government bond yields that went back to 6.85%.
Expectations have now increased for further rise in bond yields and investors in bond funds are feeling uncertain about the future returns.
Many have been debating about the optimal strategy for such situations. While on one hand, bond fund net-asset values have dropped in recent days, experts were forecasting a steep decline in bond yields, in the aftermath of demonetization.
Should one book losses, remain invested in the hope of a miracle rebound, or top up? It is hard to answer these questions. If one were to look back, situation was somewhat similar even in 2013. While RBI cut rates in January 13, it resorted to a steep rate hike in August’13. Much like now, then also, the reason behind the change for the course correction was very much a turbulent and volatile global environment besotted with fears of withdrawal of quantitative easing by the US Federal Reserve (Fed).
Further, there is a lesson in how RBI acted in these two instances. It is exemplary as to how RBI has repetitively been successful in managing difficult situations and bringing back health and strength to financial markets through its timely and prudent measures. Seems like RBI is always willing and quick to respond to evolving situations. In an objective way, it is equally willing to cut or hike rates and change the action rather frequently depending on its policy goals and incoming data points. It focuses on what it can control and rather than worry about what it can’t control, prepares for it.
Another aspect to note is the pace at which the economic environment or market sentiment change without forewarning. Looking back at just the last six months, very few advance predictions were accurate on the huge swings in interest rates that happened and almost none on the reasons why it happened. It is futile to try and predict the course of market, something that even the most successful market veteran is also not involved in. Instead, much like effective regulators, they are always prepared to respond to any change in fundamentals or other relevant factors.
So, while there is no right answer, there is one lesson for sure. Stop worrying about forecasting the way in which interest rates are going to move since that is almost an impossible task to accomplish. At best, one may have a reasonable foresight for the near term, much like one sees the road ahead clearly till the next turn, and market is ready to deliver a turn and twist every morning. And that’s of no use for long-term investors. Instead, focus on funds that adopt strategies of aligning to emerging environment, that have the flexibility to recalibrate portfolio as and when required.
Moreover, in times of a compulsion of staying invested for a minimum of three years to be eligible for tax advantage, that sounds good given that market conditions change ever so frequently.
Debt funds have had a good run, perhaps one of the best, after 2001-04.
While there is huge mental barrier to long-term investing in debt funds to maximise returns and instead look for safety in other alternates, the only magic formula for maximising long-term returns is to remain invested through volatility in a high-quality portfolio.
Hence, choose a dynamic bond fund which has a well defined investment process that realigns portfolio in line with changing market conditions and invests only in a very high quality portfolio.
And then, stop worrying about which way the interest rates are headed and instead focus on understanding whether the debt fund is following the stated strategy.
Many funds have failed to deliver because they run like a bond fund leading to the disappointment of multiple investors, because they monitored returns and not the process.
Invest in a fund that has a well-defined process for minimum disappointment. In the long term, as long as economic environment dictates market action and the market action dictates the fund action, returns are only going to be a natural outcome and not any magic.
The writer is head-fixed income, Mirae Asset Global Investments (India)
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