Longer tenure bond funds top the returns charts in 2020, shows data

Longer tenure debt funds topped the returns charts in 2020, aided by a falling interest rate environment.

Four such categories – long duration, gilt with 10-year constant, gilt, and medium-to-long duration -- have given double-digit returns. Shorter duration funds fared poorer, while credit risk funds were the worst category with returns of 0.3 per cent.

The Reserve Bank of India (RBI) continued its easy monetary policy in 2020 by cutting policy rates and infusing liquidity into the banking system. The repo rate was reduced by a cumulative 115 basis points (bps) and the reverse repo rate by 155 bps. This was after a 135 bps reduction in policy rates in 2019. The reduction in rates has especially benefited long-tenure bond funds as bond prices rise when interest rates fall in value, and vice versa.

“The year 2020 was characterised by rates cuts until the first half which led to capital gains across the fixed-income yield curve. Surplus liquidity continued to hog centre stage and kept the yield curve well supported. We also saw the RBI doing open market operations/operation twists to keep the long end of the G-sec curve well bid,” said Lakshmi Iyer, president and chief investment officer (debt) & head-products, Kotak Mahindra Asset Management. The repo rate currently stands at 4 per cent and the reverse repo rate at 3.35 per cent.

According to Dwijendra Srivastava, CIO-fixed income at Sundaram MF, banking & PSU funds, as well as corporate bond funds have given better risk-adjusted returns compared to long tenure funds, with higher safety in both credit and duration. “Most of these funds would be of medium duration, typically 3-4 years. Around 80 per cent of corporate bond funds, for instance, have positioned themselves as AAA-rated oriented schemes,” he said.

Going into 2021, the drivers of fixed-income performance are likely to change as the room for further rate cuts may be limited. “The best of the bond market rally is now behind us. Currently, bond yields are at multi-year lows and scope for capital gains look limited. So, in the new year, investors should lower their return expectations from fixed-income funds,” said Pankaj Pathak, fund manager-fixed income, Quantum AMC.

Pathak expects the RBI to begin the normalisation of the monetary policy and reducing excess liquidity by the middle of 2021. In such a scenario, overnight and short-term interest rates may begin to rise, he says, which is positive for prospective returns from liquid funds. “The theme for 2021 would be to ‘chase the carry’; capital gains may likely play second fiddle to the bond markets,” said Iyer.

Srivastava said those with a one-year investment horizon can invest in short-term funds with a duration of 1-3 years.

Investors could also adopt a strategy where they distribute their money in the mid- and short-duration buckets, he said.