Understanding Fixed Income Investing

I have been trying to understand how does the fixed income scenario really work and finally i think i have gotten some semblance of understanding of it.

Its quite simple really as long as you understand the basics and like my dad always says-" understanding the problem is half solving it."

If you look at fixed income products , there are three critical levers to make money.

1. Time horizon of the investment. Every product has a time horizon- very short term, cash market, short term, medium term and long term. For example you can open an FD even for 10 days, or for 10 yrs!
2. The return that you are being offered.
3. The interest rate environment- upward, downward, stable.

So , when you invest in a mutual fund, you need to understand what is the strategy of the fund- does it invest in long term securities, or short term , or it is a combination of both. One should look at what is the portfolio of the fund and what is the horizon of the term of deposits it holds. One can easily get this information from different sites. I usually use http://www.moneycontrol.com/

Lets look at how different types of interest rate environment impacts fixed income securities.

Upward Bias

In an upward bias scenario, it is expected that interest rates will firm up ( go up) and hence it is best to invest for a shorter period of time so that when interest rates do firm up, you can make use of the higher rates to increase your portfolio returns. From a mutual fund point of view, buy into funds which have a short term horizon. If you have a fund which has longer term horizon- it is best to get out of it asap.

Downward bias
In an downward bias scenario, it is expected that interest rates will go south ( down)- like what is happening in the US. In this case, if a fund has a longer term horizon, when interest rates come down, the market value of those securities goes up because such large interest rates are no longer available in the market.

Stable Scenario
 In a stable scenario, the fund manager becomes extremely important, on how he balances the portfolio.In these historical performance becomes extremely critical. So look for news and interviews and feedback on the fund manager and his performance.

Sometimes one might have invested in a different geography, global fund. So in such a case it is important to understand how the interest rate scenario is panning out in the other geographies.

In short, in India , we have an upward bias- so short term funds make sense. Soon in November, RBI will come out with its credit policy and it is expected that interest rates will increase. Inflation doesnt seem to be coming down at all , todays food inflation was at 18% !! Not sure why the government is not able to control inflation- its not taking enough steps in the right direction against hoarders.

Quite simple really- as long as you understand it.

Please do evaluate how this will change your investment portfolios- evaluate and make the change.

Happy Investing.
( Dont forget to subscribe using the links on the right)