Bring in some stability to portfolios with fixed income

When we work in an environment, far away from home, and which is quite uncertain and sometimes volatile too, both in terms of work and earnings, it is important that we look for growth with stability in investment portfolios. This applies more to NRIs and much less to others. The search for stability takes us to fixed-income products. As you may be aware, fixed income or debt is one of the primary or traditional asset classes. It finds a place in portfolios irrespective of whether one is a conservative or aggressive investor.

The stability for an NRI’s portfolio is provided to a large extent by the coupon or interest from fixed income instruments at periodic intervals like every quarter or half-year and sometimes annually. This coupon or interest is a pre-fixed rate, fixed at the time of the issue of the instrument. The exceptions to this are floating-rate instruments and zero-coupon bonds. In floating rate instruments the coupon varies from time to time depending upon the variations in the market rates whereas in zero-coupon bonds there is no coupon, but the bond is issued at a discount to the face value. The difference between the issue price and the face value, or the discount, is actually what one will make over time.

The movements in the fixed income markets are closely related to the movements in interest rates. High inflation, low liquidity, high level of credit growth, government borrowing program, etc exert upward pressure on interest rates. In other words, interest rates generally tend to rise with higher inflation which is generally the result of a high rate of economic growth. The reverse happens when there is sluggishness or recession in the economy. Therefore, it is a market that moves on interest rate expectations and has a science and method to it.

All fixed-income investors, especially NRIs, should bear in mind the fact like other investments fixed income investments carry both interest rate risk or price risk, and credit risk. When interest rates go up the portfolio value comes down and when interest rates come down the portfolio value goes up. This variation in the actual value of the portfolio in line with interest is called interest rate risk. The interest rate risk is linked to the maturity profile of the instrument. The longer the maturity the higher the risk and vice versa. That is why, when interest rates are rising, it is advised that one may stick to short maturity papers or bonds because the loss arising out of adverse interest rate movements is quite low in short maturity instruments.

Another risk in fixed income investing is credit risk. This is a risk related to the issuer of the instrument. Is the issuer of the bond, who has borrowed money through the instrument capable of paying the periodic interest or coupons, and returning the principal on the maturity date? This is linked to the credit rating of the instruments, where the highest safety is indicated by AAA and then AA and followed by A, and so on. AAA indicates the highest level of safety. While the ratings of the instruments are available from credit rating agencies that specialize in the rating job, it may not be an area for the layman to decide on the credit comfort of an issuer or an instrument. It falls in the realm of trained professionals. Banks and financial institutions, and mutual funds, etc have their credit evaluation teams and they have a regular flow of information relating to the credit profile. Never be carried away by a high yield available from a bond or paper with a low credit rating.

As stated earlier, the fixed income component of the portfolio gives stability to the portfolio. This is because irrespective of the market conditions, the coupon or interest from these instruments is received at periodic intervals like quarterly, half-yearly, or on annual basis. These inflows ensure that one receives something from the investments. That is not the case with real estate or gold or equities.

Yet another feature of fixed income is that the level of volatility is also relatively less as the interest rates move in a very scientific manner, and in a very studied way, linked to economic fundamentals. This reduces the scope for movements based on sentiment and emotions and rumors which one may see in other segments of the market, like currency or equities. It is also a favourable factor that these instruments are relatively easy to liquidate and realise the value in case of emergency.

It is possible to buy and hold individual instruments like bonds and securities issued by various companies. While it has its own advantages, a better idea would be to look at good mutual fund debt schemes. The mutual fund schemes have portfolios that contain a number of instruments issued by different issuers. The advantage of such diversified portfolios is that one reduces the level of credit risk significantly by owning smaller quantities of several papers in the portfolio. In the case of an individual buying a bond, a credit evaluation has to be done by the investor himself. But in the case of investments into a mutual fund scheme, the same is already done by a team of trained professionals while selecting the instruments.

For NRIs, fixed income offers several avenues for short-term parking of surplus funds, not only treasury bills and commercial papers but also overnight funds and liquid funds, etc. For longer-term investments, there are schemes like corporate bond funds, gilt funds, short-term funds, Banking and PSU debt funds, etc in the mutual fund’s space. It is also a good avenue for those NRIs who are planning retirement and would like to receive regular and stable cash flows from time to time. Well planned and timely investment in the right kind of funds, debt mutual funds may offer significant value to portfolios for long-term growth.

Disclaimer:
“The views and investment tips expressed by the expert are his own and for information purpose only. Any advice shared by the expert needs to be checked with the independent financial adviser before taking any investment decisions.”