More rate hikes? Should mutual fund investors be worried?

The US Federal Reserve is likely to raise interest rates to tame inflation. The Fed is likely to raise interest rates by 25 basis points, but some officials favoured a bigger 50 basis points hike. The Economic Times reported that even Indian policy makers are divided on rate hikes. While some favoured a calibrated approach, others cautioned about the inflationary pressure.

It is widely accepted that the Fed influences the central banks world over in setting interest rates. Most central banks would wait for clear cues from the Fed before pausing or start cutting interest rates. It is now clear that the inflation is sticky in the developed markets and it will be a while before central banks pause. Now the question on everyone’s mind is whether the hikes would be mild or steeper.

This presents a unique situation for the Indian markets and the central bank. The RBI acknowledged in its last policy review that inflation was still a worry and it is too early to take a call on its future course. However, most money market pundits believed that we are at the fag end of rate hikes and the RBI will mostly hike rates once in this calendar year. This has been widely questioned now since global central banks are pursuing more rate hikes to tame inflation.

Now the big question: how will it impact your mutual fund investments? First, the stock market is likely to be nervous in the coming months. Many stock market analysts believe that the current year is going to be muted and the market is likely to move in a tight range. So, don’t expect great results from your equity mutual funds.

Mutual fund advisors say investors should stick to large cap mutual funds and flexi cap funds in 2023. They caution investors against taking aggressive bets as the market is likely to see a lot of volatility and risky bets may be too hot to handle. In short, go easy on your small cap schemes and sector/thematic schemes.

The year 2023 was supposed to be the year of debt mutual funds. It still might be, but some more pain may be in store for the next few months. Many debt fund managers believe that debt mutual funds will start offering better returns only when it is almost certain that inflation is under control and more interest rate hikes are unlikely. That means you should continue to stick to short term debt mutual funds if you want to play it safe. Invest in liquid funds, low duration funds, and ultra short term funds to park money needed for very short term needs. If you have three years or more, you can invest in corporate bond funds, banking & PSU funds, dynamic bond funds, among others.

Get into long-term funds and gilt funds only if you have a long investment horizon and ability to take short term losses and volatility. These schemes wil face rough weather if uncertainties over rate hikes persist, say mutual fund advisors.