Fund houses, insurers build duration in anticipation of interest rate cut

If they increase duration now, with a rate cut the value of investments will rise significantly, say experts

Fund houses and insurers are in the process of building duration in anticipation of an interest rate cut by the Reserve Bank of India (RBI) expected later in the current financial year. According to experts, if they increase duration now, with a rate cut, the value of these investments will rise significantly.

Duration is measured in the number of years and is a measure of sensitivity of the price of fixed-income instruments to a change in interest rates. Interest rates and bond prices move in opposite directions. Fund houses and insurers have increased duration by one to five years since April. Fund houses have been recommending investors to buy duration funds, as the net asset value of such funds will sweeten significantly with a repo rate cut by the RBI. Expectations of a rate cut is high thanks to the softening of inflation numbers.

Consumer price index (CPI) inflation cooled down to 6.46 per cent in September this year, the lowest since January 2012, owing to falling prices of fruits and vegetables. It is expected that the CPI inflation numbers for October would fall below six per cent.

“We have been gradually increasing duration across all our duration income funds. The build-up of duration is a combination of corporate bonds and government bonds. We have increased our duration by at least 1.5-2 years, in the past month. The average maturity in duration funds is 10.5 years currently. In September, this was 8.5 years,” said Dhawal Dalal, executive vice-president and head of fixed income at DSP BlackRock Mutual Fund.

Among insurance products, traditional portfolios are seeing an increase in duration. S Prabhu, vice-president and head of fixed income at IDBI Federal Life Insurance, said: “Traditional product portfolio is long term in nature and, hence, investments are also done in long-term securities. With inflation moving downward as also the crude oil prices, we have increased the duration.”

With unit-linked products (Ulips) having a shorter duration, some insurance fund managers are also managing duration in anticipation of rate cut expectations. Badrish Kulhalli, head of fixed income at HDFC Life said that in the unit-linked portfolio, insurance companies are increasing duration on the back of the bond rally and some rate cut expectations next year.

RBI had previously increased the repo rate in January and since then, it stood at eight per cent. The central bank aims to bring down CPI inflation to six per cent by January 2016.

On Monday, just ahead of the close of market hours, RBI announced it would conduct an open market operations sale of government bonds for about Rs 10,000 crore on Wednesday. Because of this, the bond market is set to see some corrections on Tuesday. Such corrections are seen as further opportunities to build duration.

“Our duration funds average duration was 4.1-4.2 years in April. Now this is running at 5.5 years. We are looking for some correction in yields and based on that, we will be looking at buying and increasing the duration,” said Dwijendra Srivastava, chief investment officer (debt) at Sundaram Mutual Fund.

The yield on the 10-year bond ended at 8.26 per cent on Monday, compared with the previous close of 8.28 per cent.