ETMarkets Smart Talk | Fixed income remains relevant, but corporate bonds favoured: Joseph Thomas

Fixed income remains an important component of a well-diversified portfolio, but investors should now focus on corporate bond and credit risk funds for better yields, says Dr. Joseph Thomas, Head of Research at Emkay Wealth Management.

He cautions that while fixed income can offer portfolio stability, it may not always serve as an effective hedge against volatility, especially during periods of sharp yield movements.

According to Thomas, the recent rally in gilt funds has likely peaked, making it prudent to review allocations and consider corporate bonds for relatively higher accrual and limited interest rate risk. Edited Excerpts –

Q) Thanks for taking the time out. Nifty closed with marginal gains in June, but for the first six months of 2025 – it is up over 7%. How do you see markets for the rest of FY26? Any big events to watch out for?

A) The index returns give a clear picture of the market performance. It also highlights the potential for a significant improvement in the returns in the coming days.

On the large cap, the returns for the period 3 months and 6 months are 9.80 % and 6.60 % respectively, while on the midcap index it is 14.39% and 2.86 %, and on the small caps for the same period it is 16.27% and – 1.02% respectively.

You may observe a significant improvement in returns over the last three months due to the favourable movement in the mid and small cap segments.

The GDP growth, which is the most important fundamental macro factor for the equity markets has recovered smartly, clocking a growth rate of 7.40% for Q4 25.

This is a jump from the previous numbers, 5.60 % for Q2 and 6.40 % for Q3. This offers much comfort that the direction of the economy is forward, though the run rate needs to be higher in comparison to 9.50% for Q3 24 and 8.40 % for Q4 24.

The economic growth is expected to anchor around the 7.00 % plus level. Earnings too will pick up over the next two quarters.

Q) How is fixed income as an asset class looking for long term investment. How much money one should allocate as a hedge to combat volatility?
A) The allocation to fixed income should emerge from the risk profile of the investor or the portfolio composition dictated by the specific asset class preferences of the investor whether it is an individual or a different entity like a corporate or a trust.

Fixed income cannot be used to combat volatility as fixed income itself may display high volatility in times of intense yield movements especially at the long end of the curve.

But fixed income portfolios with high accruals may be able to provide the balance in times of volatility in equity markets.

Those who invested into gilt funds in the last 12 to 18 months benefited from an allocation to gilt funds and it is time now to review this exposure as the downward movement in market yields at the long end of the curve is stalled at this juncture.

Again, fixed income could be used for temporary parking in preparation for later deployment of the same in equity funds in a staggered manner.

Yields have come down drastically over the last one year, as indicated earlier, the focus in debt may be on corporate bond funds or credit risk funds which offer relatively higher portfolio yields and limited interest rate risk.

Q) How are you managing the volatility in your portfolio? Any key learnings which you would like to share from 1H2025?
A) It is not a learning of the first half but rather a key tenet of investing – asset allocation. The recency bias and the performances tend to skew the portfolio in favour of certain asset classes; we focus on regular portfolio reviews and rebalancing.

In this endeavour, risk profiling and a bespoke portfolio construction approach helps in managing volatility. To let the investor benefit from volatility we have been suggesting our investors, since mid - 2024, to stagger the investments in riskier assets.

Q) One of the reports suggested that India Inc.’s profits have grown nearly 3x faster than GDP since FY20. What structural factors are driving this divergence?
A) I believe this should not come as a surprise. The profits of India Inc. are represented by the listed players whereas GDP is a much broader representation of the overall economic health. The well managed organised players are expected to outperform the economic growth rate.

Q) With the China+1 theme gaining traction, which Indian sectors are best placed to attract global capital and scale?
A) The China+1 strategy is essentially a strategy for diversification and de-risking. It has also implications for the cost structure. While it gained prominence in the post-pandemic era, the strategy is gaining further traction now. This is due to multiple factors including geo-political factors, rising costs etc.

The posture of the current US government and administration also has added to this as the US is bent upon reducing the trade surplus with China at any cost.

This has resulted in certain manufacturing businesses diversifying into countries like India. A very recent example of mobile manufacturing.

The share of China has already come down by 5% by 2024, and that of India’s is rising. Pharma, Specialty Chemicals, Automotive components, Textiles, Electronics, IT Services are some of the sectors that are likely to benefit the most.

Q) Which sectors are likely to remain in the spotlight in 2H2025?
A) We believe Consumer Discretionary may surprise positively as the effects of tax benefits and rate cuts seep through the economy.

The expected revision in government employee pay scales may also provide some tailwinds. The themes that stand to benefit from enhanced government spending are Infra and PSU.

Q) Can we say that we are in a "stock picker’s market" ahead. If yes, what are the key traits investors should look for in FY26 picks?

A) The best way to navigate a market like this is to look for good stock pickers, i.e. fund managers. The focus should be on investing in managed products such as mutual funds, PMS and AIFs.

Stock selection does not only include fundamental and technical analysis but also handling behavioural challenges.

A rising tide has lifted all boats over the last year and a half, going ahead it would be advisable to book profits in direct equity positions and engage with wealth managers of repute to help them in identifying good funds that match their risk profile and investment objectives.

Q) Gold has also seen a tremendous run in 2025 – how do you see the yellow metal shining in 2H2025? Time to book profits or add on dips?
A) The gold prices in international markets are in a consolidation phase. Such consolidation almost always prepares a launch pad for the yellow metal to move up further. From the beginning of 2020 to almost the middle of 2023, gold prices were trading below the US$ 2000 level.

It was in Sept-Oct 2023, that gold prices broke through the US$ 2000 mark and started moving up. The current focus of the markets is on two factors, the first is the direction of US interest rates.

With the Fed on hold as it is still unclear about the likely impact of the tariffs on the US retail prices, one of the major triggers for gold is absent.

However, given the economic conditions and the relatively lower inflation numbers, the likelihood of the Fed going in for a rate cut or two before the end of this calendar year is very high.

The second trigger is a by product of the first one, and it is an anticipated decline in the US Dollar against other currency majors. This can happen only with a sustained fall in the US Dollar yields and interest rates.

The Dollar index is at 97.00 and this marks a fall of close to 10 % over the last six months, and a fall of about 10 % since the beginning of this calendar year. This has been already priced in the gold prices in the international markets, but what we need to see is a further fall in the Dollar caused by official rate cuts and a fall in market yields.

Q) How should one play the small & midcap theme? Has the profitability improved compared to large caps – what does the data suggest?
A) The exposure to small and midcaps should be taken through well managed funds which have a log track record of delivering consistent returns. The SMID segment has two or three advantages at this point in time.

The governance standards and compliance profile of these entities have improved substantially over time with regulatory and developmental initiatives, digitization and financialization.

In the last few years, the market capitalization of these companies expanded, and this offers opportunity for large ticket investments by both local and overseas investors.

The potential for business and revenue growth is the highest in these segments and therefore the potential for price performance.

The interest rates shaving come down and the transmission being under progress, the benefit of this situation with smooth liquidity conditions will accrue mostly to these entities.

(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)