Fixed-income products attractive again as markets take a breather

• Economies around the world are focusing on attaining growth and taming inflation by increasing borrowing rates.
  
  
• The rising borrowing rate environment has made fixed-income products far more attractive compared with equity investments that are facing risks of high valuation and macro headwinds.
  
  
• Analysts say that this is a good time to look at fixed-income products because the rate hike cycle has almost peaked.
  

After a long time, fixed income products have emerged as an attractive investment opportunity, especially for retail investors. This is because economies are focusing on attaining growth and taming inflation by increasing borrowing rates.

Due to high inflation, the US central bank has taken measures to stop its economic stimulus – also known as quantitative easing – that began as inflation rates shot up. The US Federal Reserve has raised interest rates by 450 basis points since March 2022. Its current benchmark interest rate is the highest since October 2007.

The idea behind rising interest rates is that it will make borrowing costs higher, which can then cool off demand and slow down inflation.

On the bright side, the rising borrowing rate environment has made fixed-income products far more attractive for Indian investors compared with equity investments that are facing risks of high valuation and macro headwinds.

Investments into good old fixed deposits of banks have regained prominence with the rising rate cycle, as banks offer returns of about 7% on such products.

Some bank with their revised fixed deposit rates as on Feb 21


Source: Axis Bank, HDFC Bank, SBI, PNB websites

Other fixed income instruments like non-convertible debentures (NCDs) are also offering higher yields to investors. For instance, redeemable NCDs issued by Avanse Financial Services recently offer a yield of 9.25% with a minimum ticket size of ₹1 lakh for a tenor of 36 months.

Equities turn volatile

A rise in the US interest rates does not bode well for the Indian equity markets, as it can lead to foreign investors pulling their money out from emerging markets like India to deploy it back in the safe and secure markets of the US or other more lucrative markets.

As a result, foreign institutional investors (FIIs) have been selling consistently in India since December and moving their investments from Indian markets to cheaper markets like China, Hong Kong and South Korea, where valuations are attractive. In January, FIIs sold Indian equities worth ₹41,464 crore and in February, so far, they have sold ₹1,567 crore equities.

Also, retail participation in equities dropped to a 34-month low in January due to a sharp fall in equities and a revival of fixed income in the wake of rising interest rates.

“Equity and debt are two different asset classes. Nevertheless, asset allocation is very crucial for consistent long-term wealth creation. Having said that, looking at the current global and macroeconomic variables, fresh allocation to fixed-income products might be a wiser investment decision,” said Marzban Irani, chief investment officer – fixed income at LIC Mutual Fund.

Irani says that this is a good time to look at fixed-income products because the rate hike cycle has almost peaked.

Fixed-income products may remain attractive at least till 2024

Moreover, fixed-income products may continue to be attractive for investors till the Reserve Bank of India (RBI) does not cut interest rates. Since May 2022, India’s central bank has raised the repo rate – a key interest rate – by 250 basis points to 6.5%.

“We do not expect any rate cuts this year in India and assign a low probability of rate cuts abroad also. In our view, the central banks may not be in a hurry to cut rates unless economic growth takes a severe downturn,” said Puneet Pal, head-fixed income at PGIM India Mutual Fund.

Inflation print for January 2023 sprung a surprise with the consumer price index (CPI) rising to 6.52% while economists expected it to be between 6% to 6.2%. Economists expect inflation to cool down to 5% by April this year, comfortably below the upper tolerance limit of 6% set by the RBI.

With inflation expected to cool down, analysts expect RBI to start cutting interest rates from next year.

“The current yields present a good opportunity to invest in fixed income across the curve from a medium-term perspective as we expect RBI to start cutting rates from 2024 onwards. With inflation expected to soften towards 5% over the course of the next two quarters, the real yields will continue to be positive across the curve. Thus, we believe that it’s a good time to start constructing a fixed-income investment portfolio,” added Pal.

For investors looking at a short-term investment horizon, Irani recommends funds in money market and liquid fund categories; and for those looking to invest beyond 3 years, he recommends medium-to-long-duration funds, banking & PSU debt funds and gilt funds.

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