Further stress for bond funds?

Bond fund managers are bracing for a tough September. Redemption pressures from Corporate India would rise on advance tax payments

Bond fund managers are bracing for a tough September. Redemption pressures from corporate India would rise on account of advance tax payments. Since liquidity in the corporate bond market has reduced considerably, heavy redemptions could send bond funds into a tailspin.

Trading in corporate bonds has dipped as yields have soared. Experts anticipate difficulty in finding takers if there's a huge redemption in fixed income funds. Bond yields can also shoot up on heavy selling, hitting the new asset values. Banks have also reduced their bond purchases due to the liquidity tightening measures.

Says Dhawal Dalal, head, fixed income, DSP BlackRock MF: “Liquidity in the corporate bond market has dried up. September is crucial, as  Rs 40,000-50,000 crore of outflows take place in fixed income funds as corporate requirements increase.”

Funds still holding a large chunk of their assets in longer dated corporate bonds could see some stress in the coming months. Those with a sizable part of their assets in cash and cash equivalents such as a one-year paper are better placed to face the redemption pressure.

Experts also anticipate stress in the short term, as the depreciation in the rupee is stoking inflation fear, leaving little room for the Reserve Bank to cut rates. Says Yadnesh Chavan, fund manager, fixed income, Mirae MF: “It is not easy for RBI to cut rates till the time the rupee stabilises. Hence, we think it's better to remain in short-term paper.”

Another development experts are keeping an eye for is a US Federal Reserve announcement on easing its bond buying programme, expected mid-September. Till now, the Fed has a $85-billion a month  buying programme. Says Dalal: “If a tapering calendar is prescribed, we may see some stress in the bond market. But if there’s no tapering calendar, we could see a relief rally. Whether the rally will reach our shores remains to be seen, as the Indian economy is quite fragile.”

In sum, bond fund investors should remain cautious. They should look at risk-adjusted returns and the underlying portfolio composition of bonds. Funds with a sizable portion of the portfolio in more liquid bond assets should be able to withstand the coming stress.