Wholesale inflation in December fell to 4.95%, while consumer inflation stood at 5.72%. Meanwhile, bank fixed deposits are yielding between 6.25% and 7.25% depending on the tenure and the size of the lender. Similarly, corporate deposits are returning 7.6% to 8.95% depending on the ratings and tenure. RBI bonds are currently yielding 7.35%.
So, adjusted for inflation, the real return based on December consumer inflation, is at least 55 basis points, or 0.55%. This is because of a softening of inflation numbers and interest rates remaining higher. Fixed income has not delivered real returns in over a decade.
“Returns from fixed income are now beating inflation. The current returns of 7-7.25% make it attractive and investors should not ignore this asset class,” said Harshvardhan Roongta, chief financial planner at Roongta Securities.
While rising interest rates have boosted the attraction for fixed income, equities have come under pressure after almost a decade of outperformance. Nifty has returned 1.5% in the past year. Many analysts believe valuations of Indian equities are rich given the rising interest rates environment.
The Nifty 50 trades at a higher PE (Price to Earnings) ratio – a popular valuation measure– of 21.7 times compared to 11-14 times for other emerging market peers. China’s Shanghai Composite is trading at a cheaper 13.37 times.
“We retain our cautious view on Indian equities. The lag effect of interest rate hikes should weigh on global growth even as the worst of inflation seems behind us,” said Kunal Vora, head India equity research, Securities. He said equity valuations look rich and whenever the yield on bonds and earnings have been wide, as it is now, market returns have historically been under pressure in the next year.
Investors confused about how much allocation should be made to equity and debt could opt for hybrid mutual funds such as balanced advantage funds or equity savings funds, which decide on their exposure to stocks & bonds based on market conditions.
Many balanced advantage funds, that mix equity, debt and arbitrage strategies based on market valuations, have an equity allocation between 30% and 50% in their portfolios these days. Similarly, equity savings funds have allocation between 15% and 40% with the balance in a mix of debt and arbitrage.
Investors looking for higher tax efficiency could add hybrid funds such as balanced advantage and equity savings, where fixed income allocations are high currently. For investors whose income falls in the lower tax brackets, a mix of RBI bonds plus corporate deposits would be a better option to put in their incremental money.