The Hindu Business Line : Debt: Your portfolio’s shock absorber

Abhilash is tired of his dad’s advice to invest in post office schemes and fixed deposits. He finds it rather amusing that somebody would want to invest in something as dull as debt instruments when the equity markets could double his money far more easily! While it is true that debt markets haven’t delivered impressive returns since 2002, debt does merit inclusion in every investor’s portfolio, irrespective of age and wealth status.

Capital preservation and income generation are primary reasons for holding debt.

Preservation

Just as one adds other classes of assets such as gold, real-estate and cash to one’s portfolio, debt is also a means to diversify your portfolio. However, debt plays a very critical and unique role that the other asset classes (other than cash) seldom perform.

Debt is a classic instrument for capital preservation. It acts as a perfect foil for equities, especially in the short term. This is because while equities have the ability to generate wealth over the long term, they can equally erode your wealth in the short term.

By adding debt to your basket, you would hold a portfolio that would generate wealth over a period and also, to some extent, insulate your total investments from short-term volatility in the markets.

For example, if you held Rs 100 in equities and there is a 10 per cent decline, you would have lost Rs 10 of your capital. Had you invested Rs 80 in equities and Rs 20 in debt, earning, say 8 per cent, then you would have lost only Rs 6.4 of your capital as the fixed income from the debt would continue to accrue even in a market decline. In other words, you would have lost less capital by holding to debt in your portfolio.

Regular income

Another feature of debt is that it provides you with regular income by way of interest, which is fixed in nature. As you inch forward towards the stage of retirement, capital preservation and income generation become one of the key objectives of investing.

Further, like all other asset classes, debt also witnesses cycles and your interest receipts on debt investments can move up or down. Even at present, returns of 10 or 11 per cent from debt are not out of reach, thanks to the innovative debt products that are now in the market. These products have been structured to effectively capitalise on the cyclical trends in the debt market.

New debt products

As young investors, it is logical for you to be aiming more at capital appreciation than capital preservation. Debt is no longer the staid option consisting of post office schemes, as new products such as income funds, fixed maturity plans, floating rate funds and special deposit schemes have actually helped perk portfolio returns on debt, helping you to make the best of interest rate cycles.

Once you decide to add debt to your portfolio, the allocation to be made would depend on your objective and more importantly, your risk appetite (or lack of it). A small note on risk appetite: Often, risk is so easily associated wit h additional returns that an investment can generate. But it may be more prudent to view risk as your ability to take losses.

Even if the objective is capital appreciation, most of us do get unnerved if our portfolio is eroded by even 10 per cent. This is why you need debt to insulate your wealth from market gyrations.

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