We continue to prefer medium-to-long end bonds: Saurabh Bhatia, DSP Inv Mgr

As the yield curve is very steep, Bhatia expects returns in the near-term to be driven by demand-supply of bonds rather than prospects of change in repo rates

High fiscal numbers are already reflecting in the extent of steepness in the yield curve and the resultant support by central bank to curtail the same, says SAURABH BHATIA, head of fixed income at DSP Investment Managers in an interview with Puneet Wadhwa. Edited excerpts:

Given the recent developments, how are the bond markets likely to play out over the next couple of quarters?

Over the past few months bond markets have been trading in a relatively narrow range. Shorter end of the yield curve has immensely benefited courtesy sustenance of the liquidity surplus. Super surplus liquidity coupled with held to maturity (HTM)-enabled Targeted Long-Term Repo Operations (TLTRO) has enabled the credit spreads to remain compressed, especially in the shorter-end of the curve.

As the yield curve is very steep, we continue to expect that the returns in the near-term to be driven by demand-supply of bonds rather than prospects of change in repo rates. Reserve Bank of India’s (RBI’s) bond buying program can aid to flattening of the yield curve, taking us closer to the end of rate cut cycle. Shorter-end segment with lower accruals and lower prospect of capital gains make way for medium-to-long term bonds until we see further flattening of the yield curve.

Do you see a wider fiscal deficit by the end of fiscal 2021 (FY21)?

We are wading through a period of substantial increase in fiscal deficit. We may not add significant layers over the current projected levels of fiscal deficit numbers for the current financial year. That said, high fiscal numbers are already reflecting in the extent of steepness in the yield curve and the resultant support by central bank to curtail the same. These phases of very steep yield curve denote a nudge by central banks (across the world) to add one layer of risk to the fixed income investments. This layer can be in the form of duration risk or credit risk. Once the curve flattens at lower yields, it marks the end of the rate cut cycle and the beginning of the growth cycle. Credits tend to outperform through this phase of positive growth momentum and lower cost of money.

What has been your investment strategy since the past few months?

We continue to prefer medium-to-long end bonds. In the shorter-end segment, bonds maturing in the first half of calendar year 2022 (H1-2022) are preferred.

Are the bond markets factoring in continued liquidity by the global central banks at this stage?

Given the extent of policy measured adopted by central banks, including conventional and unconventional measures, we expect high rate of conviction on growth reversal before we see any prospects of withdrawal of liquidity. As things stand, when we see green shoots in the economy on one side and certain parts countries are initiating further lockdowns. There still are unknown risks and till they persist, one way to navigate this phase is by apportioning investments in short-term roll down funds and funds that bear flexibility to operate at higher duration. This will not only help in providing the benefit of flattening of the yield curve, but also immune the overall investment from extensive volatility.