Invest in long-term debt? Dynamic bond fund managers on the fence

With the interest-rate hike cycle nearing its end, is it the right time to shift debt allocation to longer-duration papers?

Mutual fund (MF) managers are divided on this.

In November, nearly half the dynamic bond fund (DBF) schemes raised the allocation to medium-to-longer-duration papers, while the rest either increased allocation or kept the overall duration of the portfolio unchanged.

DBFs are debt MF schemes similar in concept to flexi-cap funds in the equity space. DBF managers have the flexibility to switch allocations between shorter and longer maturity papers depending on the interest-rate cycle.

An analysis of the portfolios of DBFs reveals that eight schemes raised their allocation in medium-to-longer duration papers (mostly government securities), including SBI MF, Aditya Birla Sun Life MF, Canara Robeco MF, and Union MF, as evidenced by a rise in the average maturity of their portfolio. The ones to trim allocation in longer-duration papers were IIFL MF, Kotak MF, and Quantum MF.

While most fund managers agree that the interest rates will tap out after one or two more rate hikes of smaller quantum and yields may not rise in tandem, not every fund manager sees merit in raising the fund’s duration just yet.

Dinesh Ahuja, one of the fund managers of SBI DBF, says they have raised the allocation to longer-duration funds on expectations that growth and inflation will moderate next year.

Parijat Agrawal, who co-manages Union DBF, shares a similar rationale behind raising allocation to longer-term papers.

“At this juncture, it makes more sense for DBFs to stay at the longer end of the curve. This will help lock in higher returns for a longer period,” says Agrawal.

Fund managers on the other side of the divide feel that shorter-to-medium-duration papers are more attractive right now.

“The overall economic growth remains strong with high credit growth and elevated fiscal deficit. This effectively means there will be a requirement for resources - both from the government and the private sector - thereby maintaining pressure on short-term rates. Hence, short-term rates will continue to remain attractive," said Manish Banthia, Deputy Chief Investment Officer (CIO) - Fixed Income, ICICI Prudential MF.

"On the other hand, the 10-year point of the curve has a very low-term premium and almost negligible margin of safety, given the prospect of decent economic growth, coupled with a very low probability of rate cuts," he added.

IDFC MF says the average maturity of its DBF is in line with its belief that the three- to five-year maturity government bonds are best suited to the present environment.

“We aren’t as convinced for longer duration (10-15-year maturities) for a variety of reasons,” the fund house said in a note.

Pankaj Pathak, manager-fixed income at Quantum MF, says the shift to shorter-duration papers in November was a tactical call.

“The market is range-bound and hence, whenever yields of longer-duration bonds hit lower levels, we reduce allocation,” he observes.