Let debt play a part in your portfolio but consider these factors before investing

With the extended bull run in the stock market which saw the BSE Sensex cross the 60,000 mark and Nifty50 touching record highs, the ‘buy on dips’ advisory gets louder and more and more money starts chasing stocks. However, when valuations are rich and the risks are high, investors should be careful while pumping money into equities. The wise investor would allocate a decent amount to debt to maintain portfolio stability.

“Debt Investments must be an important ingredient to one’s overall portfolio as it provides a relatively lower correlation with many other asset classes and helps in aligning the overall portfolio risk in line with the risk appetite of investors. Additionally, debt investments also play a complementary role along with other asset classes in achieving a specific financial goal. While the broader asset allocation may depend on one’s overall risk profile, fine-tuning amongst the asset classes may be required from time to time depending on the relative attractiveness of respective asset classes,” Vikas Garg – Head, Fixed Income at Invesco Mutual Fund said. However, debt investment too has its own nuances. Here are a few points you should keep in mind while investing in debt.

The risks

Many investors make the mistake to think that debt investment is risk-free. However, there are risks involved which should be understood. “There are certain factors to be always kept in mind e.g. investment horizon, credit quality of the investment, liquidity, etc. The usual risks of debt investment are there e.g. interest rate/volatility risk, credit risk, liquidity, etc. At this point of time, the RBI may hike interest rates. Currently, investors maybe a little more conservative on interest rate/volatility risk. As and when interest rates move up, the impact on the portfolio would be adverse as long as interest rates are moving up,” Joydeep Sen, Author and Corporate Trainer (Debt) said.

The inflation factor

Inflation has a role to play in how debt instruments perform and rising inflation negatively impacts bond funds. “Inflation is the key determinant as far as the performance of debt funds is concerned. Higher inflation leads to an increase in interest rates, which are generally bad for bond investments. The longer maturity bond funds are more sensitive to interest rates. The main risks in bond funds are that if inflation remains high and interest rates go up, the funds could underperform and deliver low returns for a while. That risk can be mitigated by spreading one’s funds across funds of different maturities and remaining invested through the market volatility if any,” Sandeep Bagla, CEO, TRUST MF, said.

Right investment horizon

There are debt products matching various investment horizons. Right from 1 day (Overnight Funds) to 7 days (Liquid Funds) to 10 years / 20 years (Gilt Funds), there are matching products. There are perpetual bonds for very long horizons. “Instead of matching the horizon with the product, investors can match the product with the horizon. Since possible risk in interest rates does play a role; you may be a little conservative now while matching the product with the horizon. As an example, for a 5-year horizon, instead of a fund with 5 or 6-year portfolio maturity, you may prefer a fund with maturity roll-down (progressively reducing portfolio maturity) as the volatility will be progressively lower as portfolio maturity comes down,” Sen advises.

Prefer mutual fund

Garg pointed out mutual funds have a range of products with various durations to choose from. “Debt mutual funds provide investment opportunities across the rate curve right from 1 day to more than 15 years also and can be used actively to meet specific requirements,” he said.
Bagla agrees. “Investing through mutual fund debt schemes is always a preferred option as fund managers are equipped to manage the credit, liquidity and the price risk of the bond portfolios in a cost-effective way,” he said.