Rising yields boost appeal of low tenure debt funds, say experts

Yields on government securities have risen over the past two days as the Centre increased the fiscal deficit target and borrowing target for the next fiscal year. Amid expectations of yields to inch up further over the next few months, investors should invest in lower duration funds and target maturity funds, according to fund managers.

The Budget 2022-23 has continued its focus on supporting growth through higher capital expenditure. The fiscal deficit estimates of 6.4 per cent of gross domestic product (GDP) in FY23 and 6.9 per cent of GDP in FY22, both turned out to be slightly higher than market expectations.

Market participants stated the gross market borrowing programme for FY23 is significantly higher at Rs 14.95 trillion, which has led to the sharp surge in the yield of 10-year government securities (G-Sec).

On Wednesday, the yield of 10-year G-Sec was trading at 6.88 per cent; over the past month, the yield has increased by 43 basis points (100 basis points equals 1 per cent).

Axis MF in its note said the Budget was a sentimental let-down for the debt markets. The significantly higher borrowing target along with the global inclusion dampener will see rates moving higher incrementally.

“Investors looking to allocate to debt strategies are advised to look at fund segments with lower duration profiles and use target maturity strategies to gradually lock in incrementally higher rates over 6-12 months. Bond yields are likely to see increased volatility and hence, investors should remain vigilant in their allocations,” said Axis MF.

Over the past week, several long fund categories have seen negative returns. The data from Value Research shows that average returns generated by 10-year constant duration funds have given negative returns of 1.07 per cent. Long duration funds and gilt funds are down by 0.66 per cent and 0.44 per cent in the past week.

Puneet Pal, head-fixed income, PGIM India MF said: “Given that the rate cycle is turning with the Reserve Bank of India (RBI) expected to raise the rate in FY23, we believe the curve can continue to remain steep and with long bonds remaining under pressure on higher borrowing. We continue to advice investors to stay in short duration funds (1-3 years’ duration) as the RBI will not be aggressive in hiking and the short end of the curve will continue to be supported by excess liquidity.”

The prices of fixed-income securities are governed by interest rates prevailing in the markets. Interest rates and the price of fixed income securities are inversely proportional. When interest rates decline, the prices of fixed-income securities increase. Similarly, when there is a hike in interest rates, the prices of fixed-income securities come down.

Morningstar India in its Insights stated: “We continue to maintain our exposure to the credit segment as it looks attractive relative to the G-sec segment from a risk-reward perspective.”