Investors should expect further interest rate hikes: Debt fund managers

The Reserve Bank of India (RBI) on Wednesday made a surprise announcement by increasing the repo rate by 40 basis points (bps) to 4.4 per cent with immediate effect. Debt fund managers in the country say investors should expect further rate hikes and look to invest in money-market instruments, floating-rate funds, and target-maturity funds.  

“Debt mutual funds (MFs) will see a loss on Wednesday across the maturity spectrum. However, one can start investing in funds up to a two-year maturity, especially roll-down funds like TRUSTMF Banking & PSU Debt Fund, which will have a yield of 6.25 per cent now. Sep­tember is when I expect most of the turmoil in bond markets to be largely over and investments in long bond funds could be ma­de then,” says Sandeep Bagla, chief executive officer, TRUST MF.

On Wednesday, 10-year government bond yields ended the day at 7.4 per cent, against Monday’s closing of 7.1 per cent.

In the past year, some debt categories like money-market funds, ultra-short-term duration and dynamic bonds have given returns in the range of 3 per cent.

Market participants expect the pace of policy normalisation to likely get faster after the out-of-turn hike in repo rate.

R Sivakumar, head — fixed income at Axis MF, says, “It would seem the RBI would want to normalise liquidity within the next 12 months, and possibly raise the repo rate above the expected inflation rate. With inflation projected to average around 5.1 per cent in January-March, it would seem the RBI is signalling repo rates to go back to pre-pandemic levels of 5.15 per cent (at the very least). That suggests further rate increases of 75 bps or more in the near term.”  

Typically, the prices of fixed-income securities are dictated by prevailing interest rates. Interest rates and prices are inversely proportional. When interest rates decline, the prices of fixed income securities increase. Similarly, when interest rates are hiked, the prices of fixed income securities come down.

Consequently, the longer duration debt instruments are more prone to intense volatility during a period of rising interest rates.

Dhawal Dalal, chief investment officer-fixed income at Edelweiss MF, says, “Investors with long-term fixed income allocation should probably wait until the June monetary policy and allocate a portion of their surplus (25 per cent) after the outcome and keep allocating 25 per cent each after subsequent policy outcomes in target maturity bond exchange-traded funds/­bond index funds maturing in five- to 10-year residual maturities, depending on their comfort.”