Which asset class gives better returns? Most market participants will invariably point at equity. Debt is termed lazy money with which one can’t really build wealth. However, fixed income has its advantages. They are relatively more secure than equity, where there is a risk of losing the principal. Also, some debt instruments have indexation benefits and the returns have full term visibility, allowing investors the advantage of planning their future financial goals better. One of the pillars of prudent financial planning is asset allocation and it is always advisable to put a portion of your investments in fixed income instruments, which balances your long-term financial goals with risk appetite. TRENDING STORIES See All Premium Forget chatbots, this is how US companies are using AI Premium Horoscope Today: Money astrological predictions for 2nd . . . Premium Marico, RP differ over FRL insolvency Premium IBC experts push for creditors’ standards Post covid, the global equity markets did exceedingly well and one of the reasons for this was central banks pumping in liquidity and governments providing record fiscal stimulus. Ample liquidity and other factors like fear of slowing economy, depressed lending rates, which when combined with a soaring equity markets and inflation, made the case weaker for fixed income as an asset diversification strategy. But we feel that the tide is turning, and one may bet on higher returns over the next three-four years from debt that may even beat the broader index (Nifty) returns. The macroeconomic scenario For the best returns, one needs to enter the market when the interest rates are peaking and exit when the cycle is at or near the bottom. In our view, we are already near the top of the interest rate tightening cycle and expect the rate cut cycle to start in current year (CY24). Globally, both growth and inflation are getting downgraded. India’s domestic growth is expected to come down from 6. 8% in FY23 to 6. 2% in FY24, with CPI inflation, according to the Reserve Bank of India (RBI), down from 6. 7% in FY23 to 5. 3% in FY24. Hence, we feel that most central bankers are at the fag-end of their monetary policy tightening, which is also evident as the US 10-year yield is trading near 3. 75% vs the Fed funds rate of 4. 75% (upper bound), thus expecting a 25 basis points (bps) cut this year and 125 bps cut in CY24. At home, we expect RBI to be on a long pause and keep repo rate at 6. 50% (outside chance of a hike towards 6. 75%). This represents an interesting case for debt MF schemes investors to lock-in a better rate and also earning a capital gain. If one assumes RBI to cut rate by 100-125 bps in next three years, this should lead to 100-120 bps in downward movement in yield for a 10-year tenor paper (7. 7% to ~6. 7% for corporate bonds/state development loans, or SDL). By doing so, investors will get close to risk-free three-year holding period return of annualised ~10%, which is 2. 3% capital gain and 7. 70% accrual (as the modified duration for a 10-year bond is 6. 66, a 100bps move in 10 years will lead to increased bond price by 6. 66, leading to annual capital gain of 2. 2% in three years). Cheaper valuation MORE FROM THIS SECTION See All Premium Premium Are constant maturity funds better than target maturity . . . Premium Premium Succession planning: How to avoid disputes after your death Premium Premium How to create a debt portfolio that can fetch 8% plus r . . . Premium Premium Which are the top most risky mutual funds in India: A b . . . Indian equity market is currently trading at a price-to-earning (PE) multiple of 20. 7, which relates to earning yield of 4. 83% (1/PE ratio), whereas a 10-year AAA-rated corporate debt/SDL is trading at 7. 70%. Assuming similar taxation is applied for a three-year debt fund and equity (with 5% indexation benefit in debt funds), even if one gives 20% premium to Indian equities, as India is a growing economy, then also debt looks cheaper than equity. Historically, we have seen that the three-year average return on investment done in Nifty 50 when PE is in range of 20-22 is 8%, and above 22, this drops to 4%. Hence, not only is one getting debt at cheaper valuation compared to Nifty 50, the risk reward ratio is favourable too. Risk, measured by standard deviation, is less in GSec AAA debt fund. Standard deviation of a GSec AAA Debt fund is 3%, which is 12% for Nifty 50. Hence after considering inherent risk in the equities, risk/reward wise, it makes stronger case for increasing your allocation towards debt at current valuations. Markets are unpredictable, and this is a good bet one can have, given the current scenario. When the interest rate cycle begins to turn benign, which we expect to happen in the next two years, one may then correspondingly reduce debt exposure in favour of other asset classes. Piyush Garg is the chief investment officer of ICICI Securities Catch all the Business News , Market News , Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates. More Less OPEN IN APP.