It is true that if you are invested over the very long-term, short-term volatility will be wiped out. But in practice, investors seldom invest for the very long-term, choosing asset classes based on immediate performance. They don’t read macro factors or the investment climate before a decision. This is why traditional investments such as gold and bank deposits hold such charm for Indian investors. But there are many macro factors that can thwart investment plans.

Beware macro factors

We’ve seen investors invest in debt mutual funds, believing that equities are very volatile. Yet understanding the debt market scenario is becoming more complex, with macro factors playing a big role. Remember how the RBI’s sudden actions on liquidity tightening in July 2013 caused debt mutual fund NAVs to decline sharply?

To make a decision on short-term versus long-term debt, you need to take a call on the direction of interest rates. The performance of debt funds is inversely proportional to the interest rate movements in the economy. One can also benefit from long-term income and gilt funds based on yield movement in the economy at an appropriate time.

To assess the portfolio composition of debt schemes, you have to understand credit risk. This means looking into the extent of highly rated and unrated debt instruments and the prospects of different sectors.

Asset allocation

All this suggests that investors have to broad base their knowledge to understand macro-economic factors. These indicators have to be aligned with your short-term and long-term goals for rational investment decisions.

Macro understanding is needed for asset allocation calls too, which are now made mainly based on past returns.

For proper asset allocation, monitoring economic trends and policies, trends in current account deficit (CAD), Gross Domestic Product (GDP), Foreign Direct Investments (FDI) and currency movements is now essential. Tracking global events like Federal Reserve announcements, currency movements and international prices of major commodities, including gold and crude oil movements, are critical too.

Sankaran Naren, Chief Investment Officer at ICICI Prudential AMC, recently pointed out that investing in equity when GDP growth and the Index of Industrial Production (IIP) growth are low have fetched a far better rate of return for investors than those made when these parameters are sailing high. On the other hand, investments in gilt funds are favourable when CAD narrows, due to its fair correlation with the interest rates prevailing in the economy.

The writer is AVP – Product Management in Cholamandalam Distribution Services Limited

Published on April 27, 2014