Don't panic about news of impending Fed rate hike

The best response will be to stick to the asset allocation in your long-term portfolios

After minutes of the US Federal Reserve’s April meeting, where a rate hike was debated, were published, and in the wake of recent statements by Fed officials, experts within the Indian financial sector expect at least one rate hike in 2016. They advise that retail investors should not react to this event in panic, but should stick to the long-term asset allocation within their portfolios.

Even if the Fed raises rates, there may not be massive outflows from the Indian markets. When the Fed raised the rate in December, the world economy was in a more fragile state. Says P V K Mohan, head-equities, Principal PNB Mutual Fund: “Commodity prices were falling, because of which the macro-economic fundamentals of many emerging markets had weakened. Since then, commodities have recovered. The Chinese economy has also stabilised. Last December there were expectations of three-four rate increases. This has now come down to two. Hence, there may not be a mad rush of funds from emerging markets to dollar-based assets.”

Moreover, markets now expect the Fed to normalise rates gradually. “Only if the US Fed moves faster than expected will there be a risk of heavy outflows. But Janet Yellen's commentary suggests gradual hikes,” says Suyash Choudhary, head-fixed income, IDFC Mutual Fund.

India’s macroeconomic situation is also stronger, with inflation, fiscal deficit and current account deficit having improved. The Reserve Bank of India has also built up forex reserves. So, even if there is some volatility, India may be affected less than other emerging markets. Some temporary outflows, however, can’t be ruled out.

For equity fund investors, this is certainly not a time to be turning their backs on equities. “The worst in terms of earnings may be over. Growth momentum is expected to pick up if we have a good monsoon. The earnings downgrades of the past three years may give way to double-digit earnings growth in FY17,” says Mohan. He further adds that India may be entering the sort of growth phase that it witnessed in 2004-07. “In such phases, mid and small-sized companies tend to expand their earnings faster than large-caps. If you have the risk appetite and time horizon, add to your mid-cap exposure if it is very low,” he advises. “Don’t exit prematurely from mid and small-cap funds after just a 10-20 per cent rally,” adds Manoj Nagpal, chief executive officer, Outlook Asia.

 

Investors in debt mutual funds should make their decisions based on the country’s macro-economic outlook, which will not change because of a rate raise. Choudhary suggests that at this juncture, investing in long duration funds may not be a good strategy, as rate cuts are largely over. He finds value at the front end of the yield curve—in one to five-year bonds. “With RBI trying to improve liquidity, these rates will benefit the most. Investors should put their money largely in short-term, intermediate and dynamic bond funds,” he says. Nagpal suggests that tax-free bonds offering 7-7.5 per cent are another good fixed-income option.

Investors should maintain a 10-15 per cent allocation to gold, as it reduces portfolio risk through diversification and even adds to long-term returns. “Despite the Fed’s rate hikes, real interest rates will continue to be negative, which will be positive for gold,” says Chirag Mehta, fund manager-commodities, Quantum Mutual Fund. He adds that the unconventional policies of central banks are not working. They will make investors across the globe nervous and lead them to invest in gold.