Bond funds to gain in days ahead

Investors locking-in at higher yields are seeing better returns and could further see their bond values rising if the RBI cuts short-term rates

Investors in bond funds could see better days ahead. With the US Federal Reserve postponing its tapering programme, the Reserve Bank of India (RBI) is widely expected to roll back its liquidity tightening measures in the coming weeks. This is expected to boost bond fund returns.

In the past month, bond funds have been giving attractive returns to investors, with yields hovering above the double-digit mark, especially in corporate bonds and short-term paper. As a result, one-month returns of debt income funds stood at 2.37 per cent and short-term bond funds 1.56 per cent, while liquid funds returned 0.89 per cent, according to data by Value Research. Annualised returns are higher.

The bond fund market widely expects the short-term liquidity tightening measures could be cut to ease the pressure on banks. Bond funds invest in overnight call money markets and some have invested 20 per cent of their portfolios in cash and cash equivalents.

Bond funds tend to gain on net asset values when interest rates fall and vice versa. When bond yields started rising in July, investors in bond funds lost in liquid funds. Bond fund managers are expecting a more stable market in the coming days against the turmoil in the past. Says Dhawal Dalal, head, fixed income, DSP BlackRock MF: “The sentiments have improved for now in the bond market. Bond funds have been making gains in the past one month and the pressures on the bond market have reduced significantly.”

The 10-year benchmark yield that surged to 9.4 per cent in August is hovering around 8.2 per cent.

Liquid funds have made returns of around 10.4-10.6 percent this past month. Earlier, RBI had hiked the marginal standing facility (MSF) rate to 10.25 per cent from 8.25 per cent on July 15. Liquid funds are now investing at these higher rates against earning a return of around nine percent before RBI tightened liquidity. Liquid funds were hit by mark-to-market losses on July 16.  

Says Killol Pandya, head of fixed income, LIC Normura Mutual Fund: “If there's a roll-back of liquidity measures, there will be a positive impact on short-term bond and liquid funds.”

Experts don't expect a rate cut though in the upcoming credit policy as inflation rate is still high. Says Debasish Mallick, managing director and chief executive, IDBI Mutual Fund: “Inflation is still too high and therefore, a rate cut does not look likely at this stage. Long-term bond funds are not likely to make bond gains.”

Nevertheless, experts opine that the pressure on the bond market has eased, and investors who have shied away from bond funds could start to take a re-look at these funds. As RBI may focus on easing liquidity, experts say short-term bond and liquid funds are better positioned to gain in the coming months.