How RBI credit policy impacts your mutual fund holdings?

As a mutual fund investor, you need to ensure that you monitor your mutual fund holdings closely. You must ensure that the portfolio mix of your mutual fund holdings is weighted towards quality stocks and not towards speculative stocks. You also need to ensure that your fund manager is not putting your money at risk by concentrating the risk on a few companies or business groups. But above all you need to understand what are the implications of regulatory and policy announcements on your mutual fund holdings. Take the case of the RBI Credit Policy which is announced every 2 months. You need to understand how these announcements impact your mutual fund holdings.

How the policy impacts your equity fund holdings…

The RBI normally provides the direction of inflation and interest rates in the policy announcement. Low inflation guidance is normally positive for your equity holdings as your real returns are likely to be higher with low inflation. Then there is the topic of interest rates. If rates are cut, it is positive for equity mutual fund holdings.

Firstly, lower interest rates ensure that the companies in your mutual fund portfolio get funds at a cheaper cost and that enhances their financial position. This reflects in the stock price of these companies and therefore on the NAV of your mutual fund holding. Secondly, equities are always valued by calculating the present value of your future cash flows. The present value is discounted using the interest rate as the base. When interest rates fall, then equities are valued higher and that translates into positive price movement. Your mutual fund NAV benefits to that extent.

How the policy impacts your debt fund holdings…

Here again low inflation guidance increases your real returns and that is a positive for your debt fund portfolio also. More importantly, the debt funds that you hold are highly reactive to movements in interest rates. When interest rates fall, it results in capital appreciation in the price of the bonds held by your debt fund. That translates into higher NAV for your debt fund. That is the reason you find debt funds tend to outperform during periods when interest rates are trending lower.

There is another factor of note in these credit policy announcements. The FPI quota in government debt is also decided in the policy. For example, the latest policy has decided to increase the quota for FPIs in government bonds by Rs.1200 billion over the next 2 years. This is a big positive for the NAV of your debt funds as higher demand tends to move up the price of bonds.

How the policy impacts your liquid and floating rate fund holdings…

Liquid funds are typically at the very short end of the yield curve. Here the yield adjusts very rapidly to changes in interest rates. Unlike in the case of debt funds and equity funds, liquid funds tend to benefit from rising interest rates and lose in a period of falling interest rates.

Floating rates are a slightly different kind of an animal. In floating rate funds your yield is pegged to a benchmark interest rate. When interest rates move up your yield on the floating rate funds also tends to go up and when the interest rates move down then the yields on your floating rate funds also tend to move down. These have important implications for the NAV of your liquid funds and the floating rate funds that you are holding.

How would this impact your mutual fund strategy?

One off interest rate changes may not be too important as their impact on your mutual fund values will not be too significant. But if there is a secular move that you see coming, then it makes sense to tweak your mutual fund holdings accordingly. Let us take an example. If you expect that interest rates are headed downwards and the RBI is likely to implement a 500 basis point cut in rates over a period of time, then what should be your strategy? Ensure that you are substantially exposed to debt funds and equity funds as both of them are likely to benefit from falling rates. Being too heavy on liquid and Floating Rate funds may not make sense in this scenario.

What do you do if you foresee a secular uptrend in interest rates? Remember, secular rate uptrend has always been negative for equities and for debt funds. In such circumstances you need to ensure that you temporarily park money out of equity and debt funds. Keep your investments in liquid funds and floating rate funds till the interest rate up-move is completed. Remember, mutual fund investment is not just about buying a fund and forgetting about it. It is also about being smart and positioning your fund holdings accordingly! You can always take the help of your financial advisor to decide on such positioning.

Learn more about latest mutual fund market news and updates at Religare Online.

For all your mutual fund queries SMS ‘ASKMF‘ to 575758 and we will get back to you.

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