A hawkish tone from RBI not good for bond funds

The expected hike in repo rate does not bode well for long-term bond funds; stay with short-term funds

As the central bank is widely expected to raise the long-term repo rate and reduce the short-term MSF rate, bond funds at the extreme end of the yield curves are likely to react differently. The RBI could raise repo rates by 25 basis points and the MSF rate by 25 basis points.

RBI’s move today will determine the course for bond funds. Long-term bond funds will be negatively impacted though short-term bond funds and liquid funds could benefit with an MSF rate cut.

Bond fund managers are however looking at whether the RBI will maintain its hawkish stance. Says Dhawal Dalal, head fixed income, DSP BlackRock Mutual Fund: “A hawkish stance will be negative for bonds.”

Bond prices react negatively to rise in interest rates, while bond prices rise when interest rates are cut. The RBI is straightening the yield curve by reducing short-term rates and increasing long-term rates. If that happens, going by the current expectations, net asset values of short-term bond funds will gain, while that of long term bond funds are likely to fall.

This past year, short-term bonds and liquid funds are among the best category of funds as per data from Value Research. Short-term gilt funds returned 9.46%, liquid funds returned 8.68%, while short-term bond funds increased 7.77%.

Long-term bond funds, however, have already begun to react negatively due to the rise in interest rates. Debt income funds returned lower at around 6.6%, while debt long-term bond funds returned merely 5.18%, as per data from Value Research.

Experts advice that investors stick to the shorter end of the yield curve for now till RBI’s stance gets clearer. Long-term bond funds could get attractive once interest rates expectations turn from hawkish to dovish. Hence, bond fund investors should stay invested in short-term bonds for now.