Faced with turmoil in Europe, a volatile market and low interest rates, investors are perplexed. Here is how you need to approach the issue.
With Europe at war, should one stay put, add on dips or cash out?
We looked at the market data with respect to some geopolitical events since 2000 – Iran drone strike against Saudi Arabia, North Korean missile crisis, Russian annexation of Crimea, First Libyan civil war, the U.S. invasion of Iraq. The equity market has generally recovered its losses over the subsequent 1-year period, with the exception being the 9/11 terror attacks.
The historical growth of the broader equity market index (S&P BSE 500) shows that markets have scaled higher peaks through time responding to drivers such as inflation, earnings growth and change in valuations. Over long horizons (10+ years), equities can be expected to deliver around 4-5% over the long-run inflation rate.
Withdrawing any corpus would lower your portfolio value to the extent of the amount withdrawn and you might lose out on any subsequent gains on the withdrawn corpus that would have accrued till the end of your investment horizon. The withdrawals defeat the purpose of investing which is to generate wealth.
Stick to your long-term strategic asset-allocation which in turn depends on your risk appetite (ability and willingness to take risk). Avoid timing the markets. You can consider re-balancing your asset allocation back to your recommended long-term asset allocation in case of any material drift due to the recent market correction. Any sharp correction in the market in response to short-term events should be seen as an opportunity to buy into the market, after weighing in any potential impact of the event on the long-run return drivers.
With interest rates likely to head north, what is the right strategy for debt fund investors?
Since 2019, the RBI has cut the policy rate sharply (250 bps) and announced a slew of measures to support the slowdown in the economy. These measures along with abundant liquidity in the banking system resulted in yields falling across the yield curve, particularly at the shorter end leading to a steepening of the yield curve.
Currently, the medium-end of the curve (4 to 7-year segment) offers an attractive yield pick-up relative to the shorter end (1 to 3-year segment) of the curve. Hence, from a risk-reward perspective the medium-term segment looks attractive. In the YTD period, the yield curve has seen an upward shift to some extent reacting to rising global bond yields amid the global economic recovery and inflationary pressures, and more recently on account of steep rise in crude oil prices.
Corporate bond spreads have narrowed significantly compared to their long-term averages (particularly for the AAA-rated segment); so subsequent widening of spreads could present additional downside risk to investors. Hence, funds with high exposure to G-secs look more suitable than corporate bond funds at this juncture.
For those investing for a reasonably long horizon (more than 5 years), one could follow a core and satellite approach for the fixed-income portion of the portfolio. The core allocation (75-80%) should be invested into shorter duration high credit quality accrual funds (short-duration, floating-rate and medium duration funds) and the rest (20-25%) to longer duration funds such as Medium-to-long term and Dynamic Bond Funds. One could consider target maturity funds (investing in government securities with 5-10 year maturities) having a maturity date close to their investment horizon. These entail minimal interest rate risk if held to maturity and also have a low expense.