Besides inflation in the fuel & light segment also increased slightly to 5.45% in October 2024 from 5.39% in the previous month.
Thus, core inflation -- which excludes food and fuel -- also rose to a 10-month high of 3.70% in October 2024 compared to 3.50% in the previous month.
Inflation in housing also increased to 2.81% in October 2024 versus 2.72% in the previous month.
In the last bi-monthly monetary policy meeting held on October 9, 2024 (before the CPI inflation data for October 2024 was released), assessing the risks stemming from uncertainties relating to the escalating global geopolitical scenario, financial market volatility, adverse weather events and the recent uptick in global food and metal prices, the RBI maintained a status quo on the policy repo rate for the tenth time in a row.
However, the six-member Monetary Policy Committee (MPC) of the RBI unanimously voted in favour of a change in stance from 'withdrawal of accommodation' to 'neutral' and decided to remain unambiguously focused on a durable alignment of inflation with the target, while supporting growth.
In contrast, central banks in several other economies abetted by disinflation have resorted to rate cuts of late.
The U.S. Federal Reserve (Fed) has cut its interest by 75 basis points (bps) to 4.50-4.75% so far this year (since September 2024), in view of solid expansion in economic activity, decrease in the unemployment rate, as labour market conditions eased, and as inflation moved closer to Fed's target of 2.0%. If the macroeconomic data stays encouraging, the Fed may continue reducing interest rates.
Even the European Central Bank (ECB) has resorted to rate cuts for the third successive time this year (in CY 2024) saying that the inflation in the eurozone was increasingly under control (nearing the 2% target) while the outlook for the bloc's economy was worsening. Given the downside risk to growth, if disinflation continues, it is likely that the ECB may cut rates further going forward to support growth.
Similarly, the Bank of England (BOE) has also lowered its bank rate by 25 bps to 4.75% in November 2024, marking the second rate cut in four years following the start of its cutting cycle in August. A few more rounds of rate cuts to reinvigorate the U.K.'s frail economic growth cannot be ruled out.
Speaking of India, the RBI expects that inflation print to remain elevated in the near term as base effects turn adverse and food prices register an upturn. Food inflation is expected to ease only by Q4:2024-25 on better kharif arrivals and rising prospects of a good rabi season.
In the minutes of the last bi-monthly monetary policy meeting, RBI Governor Shri Shaktikanta Das explains that this stage of the economic cycle, having come so far, we cannot risk another bout of inflation. Therefore, the best approach now would be to remain flexible and wait for more evidence of inflation aligning durably with the target. Monetary policy can support sustainable growth only by maintaining price stability.
The RBI Governor is of the view that currently, we need to watch out for the uncertainties on the horizon - ranging from heightened geo-political tensions and volatile commodity prices to risks of adverse weather in food inflation. These are significant risks, and their impact cannot be underestimated. We need to remain vigilant.
The other members of the MPC also seem to concur with this view. Hence, the five members, namely Shri Saugata Bhattacharya, Prof. Ram Singh, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to keep the policy repo rate unchanged at 6.50%, whereas Dr. Nagesh Kumar voted to reduce the policy repo rate by 25 basis points in the monetary policy meeting held in October 2024.
Data as of November 14, 2024.
(Source: Investing.com, Data collated by PersonalFN Research)
Persistent headline CPI and CFPI inflation and the disinclination of the RBI to cut policy rates in a hurry, seem to be upsetting the Indian bond market.
The 10-year benchmark G-sec yield since the October 2024 bi-monthly monetary policy statement has remained elevated. Watch this video:
The fact also is the rise in the 10-year U.S. Treasury yield is causing the spike in the government of India's 10-year G-Sec yield. Behind the spike in the 10-year U.S. Treasury yield, there are structural factors in play after President-elect Donald Trump's victory, and not the Fed's interest rate adjustments alone.
The volatility of yields in the Indian bond market has been low compared to that of the U.S. treasury market. However, as foreign investors shift money to U.S. securities and pull out from the Indian debt market as the yield gap between the U.S. and India narrows, heightened volatility cannot be ruled out. Note, that India's inclusion in major global bond indices, such as JP Morgan's Emerging Markets Bond Index, means high integration with global bond markets and vulnerability.
Path to Interest Rates
The path to interest rates is hinged on the inflation trajectory.
You see, while India's economy is perceived to be a "bright spot" and is the fastest-growing economy with a favourable demographic dividend and rising income, the fact also is higher food prices, light & fuel bills, and inflation in housing, are hurting the common man (despite some moderation in the past).
To address this problem, the RBI would continue to remain vigilant as regards inflation management. In the December 2024 bi-monthly monetary policy statement 2024-25, it looks unlikely that the RBI would cut the policy repo rate. A majority of the members of the MPC will vote in favour of keeping the policy repo rate unchanged for the eleventh successive time.
The MPC is resolute in its commitment to aligning inflation to the 4.00% target within a band of +/- 2% on a durable basis while supporting growth.
Perhaps in the February 2025 bi-monthly monetary policy, if CPI inflation comes down within the target range, the RBI may consider reducing the policy interest rate appropriately to support growth.
That being said, overall, it appears that we are almost at the peak of the interest rate upcycle.
Currently, the following sub-categories of debt mutual funds would be appropriate choices:
1. Liquid Funds - For an investment time horizon of a couple of months to a year, Liquid Funds can be an ideal choice.
Also, at a time when geopolitical tensions are simmering in many parts of the world and may have ramifications on the global economy and equities, it is important to consciously and strategically hold some portion of your hard-earned money in safe and liquid investment avenues.
Are you aware even legendary equity investor, Warren Buffett, strategically allocates a portion of the portfolio to short-term US treasuries?
Berkshire Hathaway's recent quarterly report, as of September 2024, reveals that Buffett is sitting on a cash pile worth USD 325.2 billion. It perhaps hints that Buffett is also turning wary of valuations in the equity markets and foreseeing challenges ahead.
For you, investors, too, it makes sense to follow Buffett's strategy and hold a portion of your investment portfolio in cash and cash-equivalent avenues.
Investing in some of the best Liquid Funds is a sensible way to hold some money safe, whereby it can offer you liquidity, help address unforeseen circumstances, and meet short-term financial goals, while the volatility in risk-on asset classes is expected to intensify.
Liquid Funds are open-ended debt mutual funds that primarily invest in short-term money market instruments with a maturity of up to 91 days.
Typically, Liquid Funds invest in money market instruments such as Certificate of Deposits (CDs), Commercial Papers (CPs), Term Deposits, Call Money, Treasury Bills, and so on.
Given the type of securities Liquid Funds hold, usually they entail low risk. They usually prioritise safety and liquidity over return.
The interest rate and credit risk are relatively low compared to the other sub-categories of debt funds.
The investment objective of a Liquid Fund is capital preservation and ensuring liquidity through judicious investments in the money market and debt instruments. It benchmarks its performance against the Crisil Liquid Debt Index and/or Crisil 1-year T-bill Index.
But keep in mind there is some element of risk. It cannot be assumed that Liquid Funds are absolutely safe or risk-free. If a Liquid Fund invests in debt papers of private issuers and compromises on quality to generate slightly better returns, the risk could be elevated. Ideally, a Liquid Fund should not engage in yield hunting to generate higher returns.
Hence, you need to be careful when selecting Liquid Funds. Don't just consider the past or historical returns as they are in no way indicative of future performance.
Likewise, avoid going by shallow mutual fund star ratings that give emphasis only to quantitative aspects. Instead, pay attention to portfolio characteristics, the investment ideologies at the fund house, the risk mitigation framework, and a host of other qualitative and quantitative aspects.
[Read: 3 Best Liquid Funds for 2025]
If you add the best Liquid Funds to your debt portfolio, it may help keep your money safe and address contingency needs. Liquid Funds are a worthwhile option over and above having money in a savings bank account.
Remember, 'Cash is King'. Holding some of your hard-earned money in a Liquid Fund shall help you sleep better at night and be in the interest of your financial well-being.
2. Banking & PSU Debt Funds - If you are looking at an alternative to park your money into a bank fixed deposit and have an investment time horizon of 2 to 3 years, then some of the best Banking & PSU Debt Funds may be a meaningful choice.
Banking & PSU Debt Funds are mandated to invest predominantly (80% of their assets) in top-rated corporate debt instruments issued by Banks, Public Sector Undertaking (PSUs), Public Financial Institutions (PFIs), Municipal bonds, and other such securities.
These entities are recognised for their robust credibility and liquidity compared to those from private issuers, making them a relatively safer investment option.
As far as the maturity profile of the debt papers is concerned, Banking & PSU Debt Funds have the flexibility to diversify their exposure across the yield curve. So, there isn't any fixed limit for the portfolio duration.
That being said, a majority of Banking & PSU Debt Funds usually maintain a duration of 2 to 5 years in their portfolio. The decision is based on the evaluation of various micro and macroeconomic factors, including the interest rate cycle.
The higher duration or maturity profile of the securities held in the portfolio makes Banking & PSU Debt Funds susceptible to interest rates, particularly in an uncertain and rising interest rate environment.
Broadly, the primary investment objective of Banking & PSU Debt Funds is to generate reasonable returns in line with the aforesaid debt and money market securities by maintaining an optimal balance of yield, safety, and liquidity. However, there is no assurance that the investment objective will be realised.
To make the best choice among a plethora of Banking & PSU Debt Funds available, you must pay close attention to portfolio characteristics (who the issuers are, the sector they belong to, the type of debt papers held, the ratings of the respective debt papers, the average maturity, Yield-To-Maturity, and the Modified Duration, etc.), the performance across interest rate cycles, whether the fund is justifying the risk taken (by considering the Standard Deviation, Sharpe Ratio, Sortino Ratio, etc.), the fund management credential, the systems and processes followed at the fund house, ideologies and risk management measures -- and not just look at the historical returns or shallow mutual fund star ratings.
Keep in mind that mutual fund star ratings aren't foolproof.
By adding some of the best Banking & PSU Debt Funds, you could potentially earn competitive market-linked returns over an investment horizon of 2 to 3 years. Around 30% of your debt mutual fund portfolio could be allocated to some of the best Banking & PSU Debt Funds.
3. Dynamic Bond Funds - To play the interest rate cycle with the expertise of a debt fund manager, some of the best Dynamic Bond Funds are meaningful, provided you have an investment time horizon of 3 to 5 years.
Regardless of the direction in which interest rates move, Dynamic Bond Funds are capable of taking advantage of dynamic market conditions and can invest accordingly to create an all-season portfolio that generates optimal returns.
As per the SEBI guidelines, invest across the duration of debt securities. They have the flexibility to shift investments between short-term, medium-term, and long-term debt securities, taking into consideration the interest rate cycle.
If the fund manager of a Dynamic Bond Fund is anticipating interest rates to fall, wherein locking in at higher interest rates is beneficial, higher allocation may be made to longer-duration debt securities.
Conversely, in a rising interest rate, the fund manager may allocate more to short or low-duration securities.
Thus, Dynamic Bond Funds take a view of the interest rate cycle and bond yields to actively manage its portfolio.
Typically, money is invested in short-term instruments, such as Commercial Papers (CPs) and Certificates of Deposits (CDs), or medium to long-term instruments, such as corporate bonds and gilt securities.
Broadly, the primary investment objective is to provide optimal returns with high liquidity through an actively managed portfolio of high-quality debt securities across varying maturities (short-term and long-term) and money market instruments. However, there is no assurance or guarantee that the investment objective will be realised.
The performance of Dynamic Bond Funds largely depends on the fund manager's judgement of the interest rate movement. If the manager fails to gauge the movement of interest rates accurately or is unable to time the investment correctly, investors may suffer losses.
The level of risk depends on the kind of underlying securities held in the portfolio. If the fund manager of a Dynamic Bond Fund invests in low-quality debt papers to engage in yield hunting, it may expose its investors to high risk.
Avoid Dynamic Bond Funds that have high credit risk -- engaging in yield hunting to generate better returns -- but, in turn, imperilling the liquidity of the portfolio.
Hence, apart from the quantitative parameters (i.e. past returns), also consider the qualitative aspects such as the portfolio characteristics, risk ratios, investment processes & systems, risk management framework, and ideologies followed by the fund house.
It is critical to invest in Dynamic Bond Funds that hold a robust portfolio of securities across maturities and high-quality debt & money market instruments. Around 25% of your debt mutual fund portfolio could be allocated to some of the best Dynamic Bond Funds.
4. Medium-to-Long Duration Debt Funds - If you wish to strategically take some interest rate risk, given that we are almost at the peak of the interest rate upcycle, you may allocate around 25% of your debt mutual fund portfolio to some of the best Medium-to-Long Duration Debt Funds keeping an investment horizon of 3 to 5 years.
Medium-to-Long Duration Debt Funds invest in various debt papers across medium to long maturity debt papers, including corporate bonds/debentures, government securities, and money market instruments.
Typically, money is invested in medium to long-maturity debt papers of private issuers, corporate debt, and government and quasi-government securities, plus hold money market instruments (Certificate of Deposits, Commercial Papers and some cash & cash-equivalents for liquidity purposes).
Broadly, the primary investment objective is to generate income through investments in a range of debt and money market instruments while maintaining the optimum balance of yield, safety and liquidity. However, there is no assurance or guarantee that the investment objective will be realised.
As interest rates have plateaued and are expected to fall, Medium-to-Long Duration Debt Funds would benefit from higher yield and unlock capital growth. This also reflects the interest rate sensitivity of these funds, other than the fact that there is a slight credit risk.
Remember, Medium-to-Long Duration Debt Funds are moderate-to-high-risk contenders. It is important to evaluate the qualitative aspects such as the portfolio characteristics, risk ratios, investment processes & systems, risk management framework, and ideologies followed by the fund house and not focus only on the historical returns.
Over a period of 3 to 5 years, Medium-to-Long Duration Funds could reward you, the investor, well provided a thoughtful choice is made and are willing to take a slightly high risk.
5. Corporate Bond Funds - If you wish to benefit by investing in quality corporate bonds, and have the stomach for high risk, you may allocate around 20% of your debt mutual fund portfolio to some of the best Corporate Bond Funds makes sense provided you have an investment time horizon of around 3 years.
Corporate Bond Funds are mandated to invest a minimum of 80% of their assets in the highest-rated corporate bond instruments (AA+ and above rate corporate bonds), alongside debt securities issued by central and state governments and money market instruments.
There is no limit or restriction on the maturity profile of corporate bonds. The fund manager of a Corporate Bond Fund considers a host of macroeconomic factors, particularly interest rates and yields, for the portfolio duration.
Taking cognisance of yields almost at the peak, several debt funds have taken exposure to longer maturity debt papers to unlock capital growth.
Corporate Bond Funds have moderate sensitivity to interest rate changes. An uncertain and rising interest rate scenario could make them vulnerable to fluctuations. But when interest rates are stable or falling, they stand to potentially benefit.
The broader investment objective of Corporate Bond Funds is to generate income through investing predominantly in AA+ and above-rated corporate bonds while maintaining the optimum balance of yield, safety and liquidity and investing across maturities. However, there is no assurance or guarantee that the investment objective will be realised.
Note, that the performance of Corporate Bond Funds is influenced by the credibility of the issuers they hold in the portfolio, the maturity of their portfolio holdings, and the interest rate movement.
It is worthwhile to go with Corporate Bond Funds that do not engage in yield hunting and jeopardise the liquidity of the portfolio to generate higher returns.
Hence, it becomes important to look at the portfolio characteristics, the risk the fund is exposing its investors to (as denoted by the Standard Deviation), the risk-adjusted returns (as denoted by the Shape Ratio, Soritno Ratio, etc.), and the investment ideologies, processes, and systems at the fund house rather than just past returns and star ratings. The future of the scheme hinges on the quality of the underlying assets or securities a fund holds.
Graph 4: Risk-Return Spectrum of Debt Mutual Funds
For illustration purposes only
(Source: PersonalFN Research)
You see, every sub-category of debt mutual funds occupies a distinctive space on the risk-returns spectrum (as seen in Graph 2).
As an investor, you need to choose the one that considers your personal risk appetite and investment time horizon.
Debt Mutual Funds are less volatile than equity funds and facilitate steady growth of capital. Debt as an asset class plays an important role in one's portfolio.
Although you may be a risk-taker or an aggressive investor, it makes sense to allocate a small suitable portion to debt instruments from a portfolio diversification standpoint (as it provides stability and liquidity).
That being said, keep in mind investment in debt funds is not 100% risk-free or safe (as in the case of an FD with a robust bank). There have been instances in the past where even the safest categories have incurred heavy losses due to negative credit surprises.
Sensibly follow the asset allocation that is best suited for you. To know how much to allocate to debt and align the investments with your envisioned financial goals, speak to your SEBI-registered investment advisor.
Whichever sub-category of debt mutual funds you choose, be mindful of the tax implications.
Tax Implications of Investing in Debt Mutual Funds
All debt funds, including Liquid Funds, with effect from April 1, 2023, the capital gain arising at the time of redemption -- whether short-term (a holding period of less than 36 months) or long-term (a holding period of 36 months and above) -- is also taxed as per investors' tax slab.
[Read: Taxation of Debt Mutual Funds - Here is All You Need to Know]
For NRIs, the capital gains on debt-oriented mutual funds are subject to Tax Deduction at Source (TDS) at the rate of 30% if STCG and 12.5% in the case of LTCG.
If you have opted for the dividend option (now known as the IDCW option), for resident Indians, any dividends from debt mutual funds (under the Dividend Option) are added to the investors' total income and are taxed according to your income-tax slab, i.e., at the marginal rate of taxation.
However, if the dividend amount is more than Rs 5,000, Tax Deduction at Source (TDS) will be first done at the rate of 10%. For NRIs, the dividend/IDCW received is subject to a 20% TDS or at the rate specified under the relevant double tax avoidance agreement, whichever is lower as per section 196A of the Income Tax Act.
Should you start SIP in debt mutual funds?
A Systematic Investment Plan (SIP) makes sense only if the investment time horizon is longer and depends on the sub-category of the debt mutual fund one chooses to invest in.
However, by and large, do note that the SIP returns in debt funds could be muted (in contrast to equity mutual funds). In other words, the rupee-cost advantage does not necessarily work to your, the investor's best advantage in case the NAV of the debt mutual fund does not move up or down much.
Therefore, it is wise to make staggered lump sum investments in debt mutual funds considering your liquidity needs and asset allocation.
[Read: Does it Make Sense to SIP in Debt Mutual Funds?]
Be a thoughtful investor.
Happy Investing!
Note: This write-up is for information purposes and does not constitute any kind of investment advice or a recommendation to Buy / Hold / Sell a fund. Returns mentioned herein are in no way a guarantee or promise of future returns. Mutual Fund Investments are subject to market risks, read all scheme-related documents carefully before investing.
Join Now: PersonalFN is now on Telegram. Join FREE Today to get PersonalFN’s newsletter ‘Daily Wealth Letter’ and Exclusive Updates on Mutual Funds.
-New.png)
ROUNAQ NEROY heads the content activity at PersonalFN and is the Chief Editor of PersonalFN’s newsletter, The Daily Wealth Letter.
As the co-editor of premium services, viz. Investment Ideas Note, the Multi-Asset Corner Report, and the Retire Rich Report; Rounaq brings forth potentially the best investment ideas and opportunities to help investors plan for a happy and blissful financial future.
He has also authored and been the voice of PersonalFN’s e-learning course -- which aims at helping investors become their own financial planners. Besides, he actively contributes to a variety of issues of Money Simplified, PersonalFN’s e-guides in the endeavour and passion to educate investors.
He is a post-graduate in commerce (M. Com), with an MBA in Finance, and a gold medallist in Certificate Programme in Capital Market (from BSE Training Institute in association with JBIMS). Rounaq holds over 18+ years of experience in the financial services industry.
Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.