All of us need equity for creating a long term corpus, but that does not mean that debt has no role to play in our portfolios. I do feel that the interest rates are headed downwards, but they are in no hurry to go down. So a bond fund will do well, but with the attendant risk of credit, reinvestment risk for the fund manager, and a clearly south bound yield. Of course capital gains by falling interest is restricted if you invest in a fund with a Modified duration of 2-3 years. Funds with longer Mod duration are more volatile, if not risky.

Recently over the past 24 months a lot of people who listen to me have invested in PSU bonds – all this money moved from FMCG stocks, banking stocks, from equity funds and of course bank fixed deposits. For most of them the fall in the share prices later on (I swear to God this was luck, but the skill to spot the 70 PE stock was not difficult). Of course a lot of money came from selling L&T, ITC, Gillette, HuL, Sun Pharma, Reliance,…so the yield on the bonds look attractive already. Most of the funds pay between 7.5 to 9% interest TAX FREE, and most of the investors are in the 30% tax slab.

One has to remember that the gap between a debt instrument (lets take it as 7% post tax) and equity (forget the historic 19% Total return over 37 years – the expected return is about 12% say) is 5%. This is a HUGE number and over a long period of time can make a huge, huge difference to your portfolio. Having said that, when the market PE is say 25 (or higher) and you have money to invest, shoring up your debt portfolio is not bad at all. Honestly, I am not a believer in market PE, but in individual PE – and for this I look at companies, groups, industry,….and not at the market PE. So when I suggested sale of the above shares I was listening to my old stock picking skills and Prashant Jain saying ‘As a fund manager for me it makes sense to sell the high PE and buy lower PE stocks’. And I picked up bonds – one caveat though – these bonds may not be very liquid, but for this set of investors, I was happy to sacrifice liquidity for profitability. After all about 2% of your portfolio being in slightly ill liquid bonds should not be an issue.

The one important thing to remember is the stock market history is a little short – and is very American. If you were invested in German stocks the hyper inflation blew your assets away. Argentina never delivered on its promise. Russian stock exchange? it is in the History books. So on and so forth.

You also need to know that the Americans are marketing people and they will market anything that will make money. The BFSI industry in the world is dominated by American noise. From the year 1900 till the 1980s the Americans dominated the world. They had slavery, the exploited the world’s resources, used political, financial, military power to capture raw materials, bribed dictators for mining rights, took over the patents of the German chemical giants, …and WROTE HISTORY of the stock exchange. They forgot to tell us one thing: “Other conditions remaining same” or “Past performance is not an indicator of future performance”.

So when you are reading the history of equities, learn about bonds too. It is a nice parking place when lunacy prevails in the equity market. The only reason why I do not like to write such articles is that this article is a caveat ONLY for those who have about 80% or more in equities, and think that this is the only way. Just to tell you that this may not be the only way. See the road not taken too.

this is not very inspiring to read, but you must read:

please remember when they talk of negative returns they mean a point to point investing, and may not include dividends. If you do a sip in a growth plan of a fund with about 70% equity and 30% debt, the longest term of negative return could be dramatically, dramatically lower, but there is no data for me to show case. I personally am not impressed with the accuracy of the Economist. That of course is a personal view.

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