How will the RBI rate hike affect your mutual fund investments?

“Small and medium-sized businesses, consumers and borrowers will be significantly impacted by RBI’s rate hike as it will result in charging higher interest rates on loans. Small-cap funds will also be unenthusiastic about borrowers. The average investor’s overall budget and savings will criss-cross as they are forced to pay a higher interest rate on a home loan or personal loan,” said Pramod Chandrayan, co-founder and CPO of FinMapp.

How will the RBI rate hike affect mutual fund investments?

Anand Dalmia – Co-Founder and Chief Business Officer – Fisdom said the main impact of the rate hike is a tighter monetary environment where liquidity is not as buoyant and borrowing is no longer cheap. In most cases, companies with heavily indebted balance sheets find profits squeezed when interest costs soar. Expect this, along with deeper discounting of future cash flows, to impact valuations for many. Equity funds with exposure to such sensitive companies will experience an adverse impact on net asset values.

“On the fixed income mutual fund side, long-dated mutual funds and long-dated gilt funds will be adversely affected. Even if the market adjusts to the policy turn, managing the debt portfolio towards the shorter end of the curve and staggered delivery should be an ideal approach in most cases,” he added.

“The mutual fund industry will also be in deep water as investors will be discouraged from putting fresh money into mutual funds,” Pramod Chandrayan said.

In such conditions, very large companies with very little debt should do well. This means your large-cap mutual funds are likely to do better in the near term.

“When investing in small-cap companies, be prepared for volatility and losses. If your mid-cap program can also face inclement weather. Unfortunately, in such difficult times, most of these companies also face corporate governance issues. So be very careful,” said Amit Gupta, MD, of SAG Infotech.

What will happen to the debt funds?

“When there is increased volatility along the curve, it is recommended that bond fund investments be biased toward the shorter end, with an average maturity in the 2.5-year range,” said Anand Dalmia.

Select banking and PSU debt funds offer a strong mix of high credit quality and a portfolio optimized for duration risk. A shorter-end portfolio with a tiered delivery approach offers the investor the opportunity to continuously invest and reinvest at higher rates, he added.

For investors seeking strategic debt allocation over a relatively definite horizon, target term funds with a hold-to-maturity approach should offer strong after-tax returns over a period of time. Again, staggered deployment in sync with scheduled policy meetings and rate hikes will help deliver better rates, he said.

Pramod Chandrayan said that as bond prices fell in the markets, there would be losses in total returns for investors invested in debt funds.

Existing debt fund investors must avoid any knee-jerk reaction at this point. It is recommended to hold the investments until one’s own investment horizon. Investors in target maturity funds that hold to maturity don’t have to worry because they’re holding on to the yield at the time of the investment anyway, Amit Gupta said.

How do long-term mutual funds benefit?

Pramod Chandrayan said those invested in large-cap funds will suffer the least because those funds invest in companies that are cash rich and can do without borrowing at higher interest rates.

Anand Dalmia said that assuming the long-term mutual fund refers to a long-term debt fund, we expect higher interest rates to effectively filter through and contribute to the portfolio’s overall returns. However, the seepage is expected to happen at a gradual pace as more clarity emerges as the central bank interprets the inflation curve and consistently communicates its stance on the issue.

Amit Gupta suggested staying away from long-dated debt and gilt funds. When you have investments, you stay invested throughout the interest rate cycle. Otherwise you will have to book losses.

What is short and medium term?

Short- and intermediate-term debt mutual funds will be relatively less affected than longer-term debt mutual funds because they have limited exposure to interest rate risk, Anand Dalmia said.

Short-term funds will also suffer if interest rates rise, but within narrow limits. They help with high short term rates as they can also support high rate reports. These funds invest in reports with maturities ranging from one to three years. If you’re funding for occasional years, they’re a viable option, said Amit Gupta.

Should You Reduce Your Investments in Stock Funds?

Anand Dalmia said there is no need to deviate from the established asset allocation unless there is a change in the investment profile that warrants a change in the strategic asset allocation. With dynamically managed tactical portfolios, we can expect the rate hike regime to boost volatility enough to allow investors to buy strong companies at reasonable prices.

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