We treat FDs or real estate — which are neither liquid, transparent or relatively tax efficient — as our youngest child and hence with high leniency

Do you invest in FDs or real estate? How to develop a framework for fixed income allocationiStock
Many of us would have had a moment in our childhood where we might have complained to our parents about unduly favoring our sibling. In 1964, Alfred Adler, an associate of Sigmund Freud, developed a theory1 on birth order and its effect on people.

As per his theory, parents usually have high expectations from the oldest child, whereas the youngest is treated leniently. The middle child on the other hand may feel excluded or ignored.

As investors too, many of us may have inadvertently been treating our investments (‘true support of our old age’) with biases.
While we have high expectations of inflation-beating returns from equities (and rightly so), we treat FDs or real estate — which are neither liquid, transparent or relatively tax efficient — as our youngest child and hence with high leniency.

Fixed-income mutual funds, despite being relatively liquid and tax efficient, are like our middle child: often ignored or misunderstood.

As a result, fixed-income mutual fund assets have not kept pace with growth in bank deposits despite the potential of delivering better post tax returns with higher liquidity. The table below illustrates this phenomenon:


When it comes to any asset class such as gold, equity or real estate, most of us don’t try to wait for the perfect conditions before investing.

The majority of savers do not wait for the World Gold Council’s annual assessment of demand/supply for buying jewellery or wait for the next result guidance of all the Nifty 50 companies for doing their SIPs.

However, many of us want to wait for certainty on rate cycles before committing ourselves to debt funds.

This makes it a tactical call rather than a disciplined asset allocation approach, which leads to a suboptimal outcome and a vicious circle of distrust in debt funds.

Historical fixed income performance

We looked at the historical performance of various indices across time horizons. As can be seen in the chart below: while fixed income returns can be volatile in a year, the volatility meaningfully reduces over a period of 5 and 10 years with outcomes in a tight range.


The below chart illustrates how CRISIL Short Term Bond Fund Index has delivered a three-year rolling 8.27% return since March 2015 on average with repo rate in the range of 4% to 7.75% during the same period.

The historical outcome also compares favourably with the average inflation of 4.92% during the same period and the post Covid average inflation of 6.12% to date (March 2020 to January 2023).

For investors in higher tax brackets, the gross returns compare positively with other asset classes with an additional benefit of high liquidity.


While an individual’s financial goals may vary, the typical reasons in favour of investing in fixed-income investments are:

1) Returns on surplus funds with relatively lower volatility
2) Steady source of income
3) Capital preservation
4) Diversification of equity exposure

We do intuitively understand the value of fixed income to our asset allocation with 52% of our financial savings invested in fixed deposits (52% as of March ‘22, Source: RBI).

While returns from fixed-income mutual funds are non-linear due to their mark to market nature (as seen in Chart 2), long-term investment in fixed-income mutual funds can give reasonable returns.

We can optimise our outcome by aligning our investment horizon with the duration and credit risk of the fund category.

Enabling macroeconomic conditions for the long-term allocation of fixed-income mutual funds

The possible reasons for tactical allocation to fixed-income funds have been the volatile nature of inflation and an unpredictable interest rate cycle in India.

However, post 2016, the RBI has adopted price stability with an explicit CPI target of 4% as its primary objective. This has imparted reasonable predictability on the central bank’s reaction function and also anchored various stakeholders’ inflation expectations, who now expect a certain action from RBI when inflation breaches a certain threshold.

The second major risk to fixed income can come from profligate government spending. However, India has been pragmatic and a calibrated fiscal policy has been consistently working to improve the quality of spending toward capital expenditure and to ensure fiscal consolidation.

Enabling regulatory conditions for fixed-income mutual funds

Historically, funds under the same generic category follow differentiated strategies, which often create confusion in the minds of an investor. However, funds are now positioned as per their duration buckets post SEBI categorisation, with credit risk also captured in potential risk matrices that makes evaluation easier for investors.


“The greatest ideas are the simplest.”
— William Golding, British novelist

As we exit the unconventional monetary policies of the Covid era, the monetary/fiscal and regulatory environment is apt for a systematic allocation to fixed income. It doesn’t mean that there won’t be any volatility.

However, the high real rates present an opportunity for investors today to add diversification to their portfolios.

The right vector to look at a fixed income mutual fund category/scheme should not ideally be the next central bank policy but whether a particular scheme fulfills our objective.

We believe that fixed income allocation can be done in the following three buckets:

1) Liquidity (0-1 year duration): To provide relatively stable returns in the near term with conservative positioning and liquidity. Suitable for investors for deploying surplus funds up to one year.

2) Core Allocation (1-3 year duration): Moderate duration funds (one-three years) offering a balance of regular income, stability and liquidity. Suitable for investment horizon above one year, with benefits of tax efficiency for investment above three years.

3) Core Plus Allocation: Suitable for sophisticated investors with a tolerance for higher volatility.

i. Credit Risk: Strategies focused on optimising yield from diversified credit risk
ii. High Duration Strategies: (3 year plus duration) Flexible mandates that can invest across the yield curve

(The author is Deputy Head – Fixed Income, UTI Asset Management Company Ltd.)

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)

(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of
Experience Your Economic Times Newspaper, The Digital Way!
Read Complete Print Edition »
  • Front Page
  • Pure Politics
  • Companies
  • ET Markets
  • More


    Social media & sharing icons powered by UltimatelySocial