Broken sentiment
A series of events and news flows dented the confidence of the markets. From fears of the government breaching the borrowing target as a result of a tight fiscal deficit target to the nervousness post Gujarat elections, all the way to the Union Budget, we witnessed relentless pounding of long-end gilts. News bytes coming out of the RBI added to the already battered sentiment. Despite a bit of fire-fighting by the government, the back of the market was already broken.
The Union Budget threw up more questions and despite the government's pronouncements, newer fears capped any semblance of positive sentiment. In the space of 3-4 months, the 10-year has swung from 7.15% to 7.88%. If one were to track the 10-year gilt from March 2017, it has moved from about 6.69% all the way to about 7.88%. To put this in perspective, the current 10-year benchmark security, i.e., 7.17% GOI 2028 was issued on January 8, 2018 at Rs 100. This security was traded around Rs 95.33 on May 25, 2018. This meant an absolute loss of 4.67% in a matter of months! On an annualised basis this is -12.44%. Remember, we are talking debt returns and not equity movement.
Equity investors would be pardoned if they think the range was too small by their market standards. Only bond investors would understand the anxiety during swings such as these. From bleeding bank treasuries to retail investors licking the wounds through their debt MF investments, large parts of the participants saw valuations take a knock down.
What now?
Election year concerns along with PSU bank write-offs will continue to haunt markets. This time around even shorter-term bonds have lost value on the back of tightening liquidity. As cash in the public's hands has gone back to pre-demonetisation days, liquidity with banks have come down. With the currency weakening sharply, RBI has had to intervene to cool the runaway movement, thus sucking INR liquidity.
What should investors do?
After enjoying high returns for a couple of years, the last one-year returns on bond funds have started to weaken. While 2016 was a year of double-digit returns, the latter half of 2017 saw sentiment turn and returns have since trended down. The best bet is to retain existing investments so long as the time frame is 3 years and above. Importantly, return expectations need to be reset to around 7-7.50%, especially since inflation has also come off from the lofty levels that were seen until the RBI started targeting the Consumer Price Index.
Nervous investors who cannot weather volatility can switch to short-term funds. If a lock-in is something they can consider, Fixed Maturity Plans (FMP) offer a compelling alternative. With short- to medium-term yields elevated, these FMPs can deliver attractive returns without having to compromise on the credit quality.
Tax-free bond yields in the secondary markets have inched up over 6.25% and offer a safe bet. Non-tax or low tax bracket investors would have an opportunity to get higher returns on fresh fixed deposits and NCD investments. Here, we wish to caution investors that it is better to stick to well rated and better known entities, rather than go for lower credit instruments. After all, investors get into debt investments for safety over higher returns.
In summary, one needs to realise that every now and then bond markets suddenly wake up to remind the world of its existence. At times when rates soften, bond investors rejoice, whereas, when rates harden, the story takes a bad turn.
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