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Balancing Risk and Return in challenging times.
Financial experts encourage equity investing as long as the investments are long-term in nature and suit the risk profile of an investor.
Photo Credit :
Gibi George: Founder and Chief Executive, The Trinity International
Financial experts encourage equity investing as long as the investments are long-term in nature and suit the risk profile of an investor. However, there are times when the equity market could be in a bearish phase or remains flat. For instance, the broader Indian markets represented by the Nifty 50 are at the levels last seen in October 2021. Between then and now, the market has seen several corrections and then advances, but has not crossed the all-time-high levels so far.
At the same time, interest rates in India and other countries have been going up in 2022. Since May 2022, the Reserve Bank of India has raised its benchmark interest rate by 190 basis points, or 1.9%. With inflation remaining higher than acceptable as per RBI’s mandate, rates could go up further.
In situations like this, investing in debt could equally rewarding as investing in equity. An investor who invested in equity in October 2021 would have earned a lower return than an investor who invested the same amount in a debt instrument at the same time. What needs to be noted is that we are able to make this observation with the benefit of hindsight.
So, how do you as an investor make the most of this situation? Let us understand some of the dynamics of the debt and equity markets at play at present.
Reasons behind high interest rates
When Covid-19 struck, most governments in the world spent a significant amount to ensure financial support to large sections of their population. Moreover, governments also had to spend money in ensuring availability of vaccines either free of cost or at subsidised rates. To support businesses, the central banks also cut rates so that the cost of borrowing becomes lower for businesses. All these measures meant consistent flow of liquidity, which caused inflation.
Then the Russia-Ukraine conflict started earlier in 2022 causing disruption in food and energy supplies globally. This too added to the inflation. Now, in order to control this inflation, central banks are increasing interest rates. As inflation is still at an elevated level, there are chances that the interest rates might go up further, and remain so for longer than expected.
Reasons behind volatility in equity markets
The high inflation could cause a slowdown in consumption. Effectively, this means that many businesses might witness a lower demand for their products and services. As equity valuations are an estimate of the future income of businesses, the current level of inflation caused a downgrade in the future revenue estimates. Accordingly, equities globally have been under pressure throughout 2022 so far. Leading indices in developed markets like the Nasdaq 100 and S&P 500 in the US have corrected to the tune of 33% and 20%, respectively, in the last one year.
How to make the most of this situation?
As an investor, it is crucial that you follow your asset allocation and invest in both equities and fixed income. This ensures that the portfolio does not come under severe stress in volatile times. That being said, the current market situation makes a compelling case for investing in both.
The current market levels mean that you are getting an opportunity to buy equities at 2021 prices. The high interest rates are an opportunity to lock-in in debt mutual funds for medium to long term at the prevailing high rates. If you are certain that you can keep the money invested for over three years, debt funds can give predictable and tax-efficient returns.
The other option is investing through hybrid mutual funds, that invest in both equities and debt, aiming to get the best of both the asset classes. Despite broader economic challenges, there could be some sectors that can benefit from the overall situation. A hybrid fund has the flexibility to take advantage of such situations. Given that the investor gets the opportunity to take exposure to both equity and debt, a rally in either of the asset classes will help the investor.
With your risk profile and financial goals in sight, you should consider these aspects for your investments in the coming times. Now is the time to start allocating to debt mutual funds apart from hybrid funds.
Founder & Chief Executive
The Trinity International, Kochi