Liquidity withdrawals will result in pressure on very short term rates in the near future and have consequences for long term rates as well. Inflation remains high, though not as high as it was three months ago. But higher price levels could be a concern due to a likely rise in oil prices and a weakening rupee, a tendency for many household items of consumption, including fruits and vegetables and protein foods, to become more expensive. ,
While an accommodative stance may continue for an extended period, market rates may rise in anticipation of tighter monetary policy and rate action. With this in mind, the product’s priorities at this point in time should reflect three things: the expected increase in interest rates over the maturity period, minimizing loss of value and ensuring the credit quality of the portfolio is of a high order, and Generating returns comparable with benchmark returns.
High accrual portfolio: one of the sensible things to do in a rising interest rate The scenario is to invest in high accrual funds. The higher accrual will enable the portfolio to substantially offset the depreciation on account of rising returns. This is because rate depreciation has to be consistently higher than the rate of accrual for the portfolio to record depreciation. Therefore, the accrual portfolio is preferred. Also, the credit quality of the portfolio should not be compromised as sometimes credit incidents may increase with increasing cost of funds.
Arbitrage Fund: Arbitrage funds are preferred for their stable returns and tax efficiency as compared to fixed income funds. For investment of short-term surplus of three to six months duration, Arbitrage Fund would be an ideal destination.
Fund Concentration in Short Maturities: To mitigate price risk or interest rate risk, the primary consideration in investing is to invest in short maturity products. While this strategy generally works well, there is another factor that must be taken into account. The secret lies in identifying funds that have a high concentration of portfolio holdings with maturity within the next one year. If a significant portion of the maturity is within six months or a year, this gives the portfolio manager an opportunity to take fresh investments in papers whose yields will be on the then prevailing yield curve. In other words, the reinvestment for this portion of the portfolio will be at higher rates. This will help increase the portfolio yield, and thus, portfolio returns.
Direct Bonds: Bonds with attractive returns and acceptable credit ratings can be chosen for the portfolio, but have a maturity profile of 2 to 3 years. In recent times, offers on some state government enterprises have come at relatively higher returns. Frustrated by the low returns from ordinary debt products, it is likely that the lure of higher returns for less credit may seem tempting, a sentiment that should be overcome with strong determination, mainly because as rates rise and liquidity dwindles. That is, many companies may face pressure arising from the high cost of loan repayment.