The Mutual Fund Show: Should Your Portfolio Change With Rising Rates?

Nisreen Mamaji: Typically, the financial planning rule is that if you are in your 20s to 50s, you will typically have a higher range in your asset allocation – the portion towards equities will be higher. And if you are in the retirement phase or approaching retirement, then you would slowly convert that into fixed income or debt.

Every time you re-balance the portfolio when the yields go up and the equity yields go down, you are not sure when to re-enter the market because that's also a question.

So, statistics has proven that when you do this, when you try to do the market timing, it does not always work in your favour because you might have just stayed in cash for a long period of time, or you might have even used that money – gone on a holiday, seen those balances in your bank account and spent the money.

If you can withstand the volatility, and the ups as well as the lows, the best thing to do for your longer-term investments – which could be retirement or buying a home or children's education – is to stay invested and not really look at the yields.

But a lot of us investors are also very panicky when the markets move up and down. In that case, a dynamic asset allocation fund is an ideal instrument for you. But the fund manager will switch between bonds, equity, as well as gold or international equities in a lot of multi-asset funds, or in a lot of dynamic asset allocation funds.

If you don't want to do it yourself and rebalance your portfolio every time the market has moved up – which is what is happening right now, and where you should be possibly selling equities and buying more of bonds, and the other way down when the cycle moves – just stay invested in our dynamic asset allocation fund.

But if your goals are further away, ignore all of this, ignore the noise and just stay invested. That would be my view on the movement.

Tarun Birani: The budget has come in and we have seen the yields have shot up after that; the pressure is seen on the longer side as well as on the shorter end. It's a very volatile environment at least on the fixed income side. One needs to be extremely cautious in terms of investing in fixed income right now.

There are three different spaces – one to three year, four to six years and eight to 14 years. Out of these, on eight to 14 years or the longer end, the government borrowing programme looks very heavy. Due to that, I would recommend currently not entering that space because it could be very volatile. We are at 680, ten-year kind of environment right now. It can quickly move up right now. So that should be avoided. Four to six (years) looks very interesting as a space where the yield to maturity is close to 625 to 630.

A rundown maturity kind of product can be looked at in that space. In the one to three years, my suggestion would be not to venture in arbitrage, overnight or ultra short-term category because this also could be very volatile going forward.

Investors, your seat belts need to be tight right now. The next one year is going to be extremely volatile in terms of fixed income because of inflation; globally and domestically, we are seeing the hawkish moves are coming and due to that the interest rates are going to be volatile. One needs to be careful there.

Talking about the equity mix, there are two approaches from a financial planning perspective. Your long-term planning is what should take over and in that, your debt equity levels should be decided based on your suitability and your long-term goals.

One important update right now: currently, as the equity markets have given phenomenal returns in the last two years, what one can look at is re-balancing. Re-balancing is extremely critical right now. So, small and mid cap as a category works – basically, these are high beta assets. In this environment where we are in right now, my suggestion is to cut all the high beta assets.

The small and mid cap portfolios need to be reduced or trimmed right now, and that money needs to come into cash. That's the tactical part of the portfolio. That's what we are currently recommending. The blue chips or the long term, what you have built in for your long term goals, they can continue to remain as they are. But small and mid cap is where one needs to be extremely careful because in these volatile times, all the assets which have moved because of this favour of this fiscal stimulus, all of this will come at an “elevator” space. They have gone as a “staircase” but they will come at an “elevator” space, so one needs to be very careful.

Nisreen Mamaji: So (the question to ask is) why have you invested in fixed income in the first place? Those could also be moved to say a floater fund, which is what we did anyway, about six months to a year back having predicted that the interest rates will be moving up in the next couple of years. Assuming that's going to happen, typically, if you are just parking your instrument money, you need parking instruments for say for one to three months, because possibly you're buying a house or a property or you need the money to put down for certain goals, then you just stay invested. There are a lot of people who are in medium-term plans, in the one-to-three-year range.

At this point of time, we have not recommended any changes or switches because of tax implications, and keeping in mind the current status of even the one-to-three year funds. We have decided to stay put (rather) than make sudden changes.

Tarun Birani: As I started my analysis on the fixed income side, currently, the money which is a three-month kind of money, my suggestion would be to keep it in an overnight fund versus a liquid fund, because in the short term, a lot of volatility could come in due to the interest rate changes. Arbitrage is also a preferred category because of the tax advantages, as well as the form-up of yields on the arbitrage side. So, there as well I see better allocations.

Nisreen Mamaji: No, (it’s) the same. Arbitrage definitely because the spreads are very comfortable right now. That is a category that we are considering plus there are tax benefits. In overnight funds or ultra-short and low duration, the YTMs are very low. So, I would prefer the floating rate in that scenario, or the alternative is arbitrage.

In arbitrage (funds), there are not really many choices to be made. The spreads are equal to all the fund managers. You can go ahead and pick whatever you are comfortable with.

Tarun Birani: Gold and silver are basically an inflation-hedge kind of asset. We are seeing an environment wherein inflation is rising, and you could see both of them can help as a cushion against this entire hawkish or inflationary trend.

We need to understand these assets from a usage point of view. Gold is normally (used) more from a jewellery point of view, silver has industrial use as well. Due to that, the volatility is much higher in silver. From a correlation point, gold has a very low clear correlation with equity, but silver has a better correlation with equity.

From that point of view, if one is looking at diversification as an objective, gold is continuing to be a preferred asset because it has a low correlation to equity.

But one can look at a combination of gold and silver. If I look at the returns of both the assets over the last five-years, it has been between 7-9% CAGR, on an overall basis.

I will be a little more cautious. I want to see how the silver ETF (does) for six months or one year and to see how systematic changes (that happen) because it's a new asset class in the Indian environment. I want to see how it pans out and then maybe, one can look at investing into this.

Nisreen Mamaji: Silver's fortune is more linked to the economic cycle, because of higher industrial use.

If you look at where silver is used, the allocation towards industry is nearly 50.7%, and towards jewellery it is only 17.8%; silverware is only 4.2%. Basically, the bulk comes from the industrial use.

Electric vehicles and the automation industries are poised to move with nearly 22% CAGR over the span of 2021 to 2025. So, there is a use for silver. For solar energy, there is use for silver, for 5G rollout as well as for semiconductors, cables, chips, and fuses. Photography has about 2.8%. So, if you consider the bulk of silver use, it is towards industrial, while 80% of gold is only towards jewellery. The industrial demand will pick up and therefore, of course, there is a role for the silver and silver ETFs.

Secondly, when the economy takes off, silver will rise higher than gold. So, when inflation is on the rise, silver will go higher than gold because silver is considered to be a slightly better inflation-hedge compared to gold.

On the demand-supply side, silver prices are more responsive than gold. Most of the central governments, pension funds and large institutional investors will hold large reserves of gold. Therefore, that lends stability for gold prices, but it is not affected by the economic decisions.

Silver also has a very weak positive correlation to stocks, bonds, commodities, and therefore, as a diversifier, gold would be a good instrument to keep.

Keeping both these views in mind, in the longer term, If industrial use is going to pick up for silver, then definitely we should keep an open mind and introduce some amount of silver, either in a multi asset form, or ETF form, vis-a-vis gold, which has been our traditional instrument for hedging.

Nisreen Mamaji: Right.

Nisreen Mamaji: The NAV stands for the net asset value and the calculation is done by the cash and securities held by that fund minus the liabilities divided by the number of units outstanding. So, that's the formula for how the net asset value is calculated.

Every day you will see that your NAV has gone up or down. That's because the stocks or securities, bonds or cash component has possibly gone up. But, the number of units outstanding has remained the same.

So, if you're looking at an equity mutual fund, the shares may have gone up simply because of demand or supply, economic news, or various other reasons.

In a mutual fund, you'll have a range. In a diversified equity mutual fund, you'll have 50 to 60 stocks, so it may not move in tandem with the Sensex or an index. But, at the same time, there will be some news, perhaps related to the pandemic or some industry or sector, which has an effect on that particular fund.

You will have thematic funds, sectoral funds like a pharma fund or IT funds, or you will simply have a diversified equity fund. In the bonds, the same situation will arise. In a fixed income fund, there will be various categories of bonds. The same logic will apply to the fixed income part of the bonds.

That is how the NAV will go up and down, depending on the price of the cash and securities of that fund minus liabilities, divided by the number of units outstanding.

Tarun Birani: NAV and mutual funds are nothing but lakhs of investors pooling their money, and they invest into an instrument, and the fund manager takes care of that.

I would strongly recommend investors to go by the four-Ps: Performance, Pricing, Process as well as Pedigree of the fund house, while selecting a fund house.

Do not go by the NAV because NAV is a very deceptive tool to analyse whether the fund is a good one or a bad one to pick up.

It is not like a stock that if it is at less price, it will give you better returns. In stocks as well, it doesn't work like that, but in a mutual fund one needs to be careful from a pedigree point of view. Those four Ps are important while selecting.

An investor should avoid NAV checking on a regular basis to make their decision to invest into a fund. It should only be driven by the strong fundamentals or your clarity about that fund house. Then only should you pick that up.