Interest rates may seem unrelated to equities, but they profoundly impact markets. Rate changes affect corporate profits, stock prices, and investor behaviour - ultimately rippling through equity funds.
Read on to understand the mechanisms behind this relationship and how hikes hit earnings growth and equity valuations while suggesting innovative investor strategies to navigate interest rate risks.
Understanding Equity Funds
Equity mutual funds invest predominantly in shares of listed firms to generate market-linked capital appreciation. Fund managers carefully pick a diversified basket of stocks with growth potential based on extensive research.
Their portfolio construction skills and active management aim to provide attractive inflation-adjusted returns over 3-5 years despite short-term NAV volatility from daily stock price fluctuations.
Benefits of Investing in Equity Funds
Equity funds offer investors several following advantages:
- Long-term Wealth Creation: Equity funds have historically delivered the highest absolute returns among major asset classes over extended periods. They harness this wealth-creation potential.
- Portfolio Diversification: Funds invest across sectors and market caps, reducing concentration risk. This diversification helps contain the downside during market corrections.
- Professional Management: Experienced fund managers have the expertise to identify quality stocks based on in-depth research. They actively track companies and industry trends.
- Easy Investments via SIPs: You can start investing in equity funds with amounts as low as Rs. 500 through Systematic Investment Plans (SIPs), making it pocket-friendly.
- Tax Benefits: Equity funds enjoy tax benefits. LTCG exceeding 1 lakh per year is taxed at 10%, while STCG is taxed at 15%. Dividends are also tax-free, up to 1 lakh per year.
Interest Rates and Equities
Why do interest rate hikes hit equity markets hard? Historical data offers clues. Take August 2012, for example. When India's benchmark 10-year bond yields crossed 9%, stock markets corrected sharply by 6% in just a few weeks.
Similarly, in 2013, mere talks of tapering asset purchases by the US Federal Reserve sent global equity markets into a fuss, with 10% plus corrections over the next two months.
The mechanism at play is simple yet impactful. As interest rates rise, the discount rates used in valuation models for equities also increase. This reduces the calculated net present value for future corporate cash flows, fundamentally declining a stock's worth as rising rates dent future earnings potential.
This fall in valuation estimate soon transforms into reality as investors sense the earning risks and start selling stocks. As more investors exit, equity prices spiral downward, sometimes triggering sharp corrections rather than gradual declines.
So, while interest rates may not affect a business's day-to-day operations, they critically impact the market's future earnings expectations and, hence, equity valuations.
Impact of Interest Rates on Mutual Funds
While the paths differ, interest rate hikes lead debt and equity funds down volatile roads:
1. Impacts on Debt Funds
- It causes higher rates to lower existing bond prices as new bonds offer higher coupons.
- The most significant impact on funds holding long-maturity bonds.
- Reduces overall returns from debt funds.
2. Impacts on Equity Funds
- Expensive loans eat into corporate profits and earnings growth outlook.
- It results in dampened investor sentiment for equities due to lower earnings forecasts.
- It parks volatility in stock markets.
- It hampers overall returns from equity mutual funds.
Navigating Interest Rate Risks in Mutual Funds
Though interest rate movements are unpredictable, investors can adopt specific strategies:
- Economic environment: Understand the financial climate and RBI's monetary policy stance, influencing rate decisions.
- Invest in short-duration debt funds: they offer stability even during rate hikes.
- Rebalance your portfolio: helps to account for market movements and maintain your asset allocation.
- Long-term equity investment: invest over the long term instead of timing the markets.
Partner with the Right Fund House
When investing in equity funds, picking an established and credible asset management company with a proven track record is crucial. You need a fund house with robust research capabilities, experienced fund management teams, and consistent long-term performance. ABSL Mutual Fund ticks all these boxes, making it a prudent choice for equity investors in India.
Powered by one of the industry's largest research teams, ABSL MF offers a winning combination of human insight and data analytics for prudent stock selection. This has delivered superior risk-adjusted returns across market cycles. With funds catering to various risk appetites, ABSL Mutual Fund provides the right solutions for different equity investor needs.
Conclusion
Interest rates significantly impact the profitability, valuations, and investor appetite for equities, translating into volatility for equity mutual funds. However, adopting a long-term orientation and suitable tactical adjustments can help investors navigate interest rate risks. Over extended periods, equity remains an attractive asset class for wealth-creation portfolios.
If you want to invest in
mutual funds in India that can withstand changing interest rate cycles, choose an established player like ABSL Mutual Fund. With prudent stock selection and consistent long-term performance across market phases, ABSL simplifies equity investing.
