Debt fund investors are in a fix. After enjoying a good year of double-digit returns delivered by long-term gilt and banking & PSU bond funds, there was a sudden surge in the 10-year G-sec yield towards the end of 2019, thus affecting fund returns. In the backdrop of rising inflation, the fear of excess government borrowing is pushing up interest rates, making investors contemplate on rebalancing their investments. The budget 2020 is round the corner and is expected to bring more clarity. Rahul Pal, Head-Fixed Income, Mahindra Mutual Fund, throws more light on many factors affecting debt investments, in an interaction with Moneycontrol’s Nikhil Walavalkar. Edited excerpts.Q: Budget 2020 comes at a time when the Indian economy is slowing down. What are your budget expectations?A: There is a need to go beyond the conventional thinking if we are looking to take the economy to the next level. Looking at the tremendous response to the Bharat Bond ETF from investors, the government should definitely think of out-of-the-box solutions. For example, I would like to see a credit risk ETF that invests in a pool of all stressed assets of banks at an appropriate discount. That will help lenders get rid of all stressed assets and start lending afresh.The government should assess if the cut in income tax really stimulates demand. Government revenues reduce when you either cut income tax or goods & services tax (GST) rates. My understanding is instead of cutting personal income tax rates, it is better to rationalise the GST rates. GST affects a far larger base of population as compared to the number of people gaining from an income tax rate cut. More money in the hand may not be spent. However, cheaper products on account of lower GST can increase demand.Q: Inflation has spiked recently. Where do you think policy rates are headed in 2020? A: If we look at the global food price indices, we see the prices going up. This could be a case of prices going up after getting supressed for a period of time. These are structural inflationary trends and India will not be an exception. Commodity prices, including those of all metals are going up. Going by history, such inflation on a global stage, does come to India, with a lag. RBI does not have the luxury to cut rates. RBI tried to address the situation by opting for Operation Twist. However, it has not worked as expected. RBI has to think of new solutions to bring down the rate of interest.The fixed income market is polarised. On one hand, we have bank fixed deposits offering 6 per cent interest and on the other, there are NCDs offering 9 per cent coupon. How do you read this situation? What are the precautions investors should take while investing?Investors suffer from recency bias. Two years back, the sentiment was buoyant and many invested in NCDs and bonds. Investors moved in herds and that made many burn their fingers due to defaults by some issuers. Investors are always told to check the fundamentals of the issuer before investing in bonds. However, investors rarely do it. Avoid concentration in your investments no matter how attractive the expected returns are. Do not chase risks to earn high returns. Build a diversified portfolio in such a manner that one default should not devastate your portfolio.Banking & PSU Bond funds and long term gilt schemes did well over the past two years. Is it time to rebalance? What are the avenues to invest at this juncture?Gilt funds have probably run the course and hereon one should moderate return expectations from these funds. Given the low probability of making money in gilt funds, it is good to book profits. However, gilt funds may see a sharp run up, if in the forthcoming budget the government announces plans to raise money from overseas markets. Banking & PSU bond funds also appear to have delivered in terms of returns; however, they still remain attractive for investors from a safety point of view.It makes sense to invest in credit risk funds now. Investors have shunned this space and the sentiment is very low. AA-rated bonds are offering attractive yields, which adequately compensate the investors for the risks they carry, compared to their AAA-rated counterparts.Gold prices have risen in 2019. Should Investors allocate funds to gold?In recent times, both gold and stocks did well, globally. Hence, it is difficult to give a directional view on gold. However, one should have allocation to gold. Gold is a good hedge if you are uncertain about currency fluctuation, government moves and inflation.Depending on your requirement, you can decide on the extent of allocation. Instead of chasing price movements in gold, it is a better idea to keep a constant allocation to gold and invest the rest in a mix of bonds and equities.Get access to India’s fastest growing financial subscriptions service Moneycontrol Pro for as little as Rs 599 for first year. Use the code “GETPRO”. Moneycontrol Pro offers you all the information you need for wealth creation including actionable investment ideas, independent research and insights & analysis For more information, check out the Moneycontrol website or mobile app.