Long-tenure gilt and dynamic bond funds shine on hopes of further rate cut

Long duration, gilt, and dynamic bond funds have outperformed in the 1-month and 3-month period

Two successive rate cuts in the past few months and expectations of further softening in the coming months have augmented the returns of long-tenure debt funds. 

Long duration, gilt, and dynamic bond funds have outperformed in the one-month and three-month period, increasing their one-year returns as well. In the past year, returns for long-duration, gilt funds, and dynamic bond funds stood at 12.7 per cent, 11.2 per cent, and 8.88 per cent, respectively — more than other debt categories. 

“The Reserve Bank of India’s open market operations and liquidity injection, along with two successive rate cuts, have helped the cause of longer tenure bond funds,” said R Sivakumar, head–fixed income, Axis Mutual Fund (MF). 

The market is expecting further cuts in the coming months as inflation remains within control. India’s headline consumer price index inflation stayed flat at 2.9 per cent year-on-year in April, with the rise in food inflation offset by lower core and transport inflation in April. 

“Given gross domestic product numbers, the market is factoring in further rate cuts. However, the cuts may not entirely transpire into lower yields,” said Vidya Bala, head–MF research, FundsIndia. 

Longer tenure funds rely on duration play and primarily benefit in a declining interest rate environment. Yield on the 10-year government securities slid below 7 per cent on Monday, the first time since November 2017. The yields have come off about 40 basis points (bps) in the past three months and 90 bps in the past year. Bond prices and interest rates move inversely.

Investors have been pulling out money from longer tenure funds after the Infrastructure Leasing & Financial Services crisis came to the fore in August. Nearly three-fourths of the debt money, as on April 30, 2019, was invested in securities, with duration of less than three years. About 67 per cent was in schemes that invest in securities with maturity of up to one year, up 7 percentage points, from a year ago.

Despite the possibility of rate cuts, experts believe this may not be a good time to invest in longer tenure funds. “While we expect some cuts in the near term, it’s unlikely that yields will come off by another 100 bps in the coming year as well,” said Sivakumar. 

“While there is some opportunity in long-term bond funds, investors will be better off investing in dynamic bond funds to capture the duration opportunity rather than absolute long-duration funds,” Sivakumar added.

Fund managers have the leeway to change the duration of the underlying portfolio in duration bond funds as the situation demands. 

“Investors looking to play the interest rate rally may do so through corporate bond funds and medium duration funds as well rather than solely betting on longer duration funds,” added Bala.