Investors need to adopt a barbell strategy for debt-oriented funds: Experts

Keep bulk of your portfolio in low-risk funds; chase returns in residual portion if you have the capacity

Yields on government securities (G-Secs) spiked on Tuesday — the 5-year G-Sec closed at 5.84 per cent (compared to its calendar-year low of 5.50 per cent); the 10-year bond touched 6.18 cent (CY low: 5.97 per cent); and the 15-year bond rose to 6.81 per cent (CY low: 6.58 per cent). These figures have moderated slightly in the past two days. But with yields under pressure, investors need to modify their debt fund strategy.

Short-term spike

Two factors caused the spike: The exclusion of popularly traded securities in the Reserve Bank of India’s (RBI’s) Government Securities Acquisition Programme (GSAP) auction, which disappointing the market, and the RBI’s announcement of a new 10-year G-Sec. When this happens, yields on older bonds tend to rise as traders exit them.

Yields under pressure  

Yields have been under pressure since the consumer price index (CPI)-based inflation for May came in higher than expected at 6.3 per cent. Though the central bank has said this is transitory, caused by supply-side constraints, some factors may not vanish quickly. Commodity prices are high globally, with Brent crude at $75 per barrel. “Increasingly, an expectation is building up in the market that inflation may not be so transitory,” says Anand Nevatia, fund manager, Trust Asset Management Company.

The economy is operating at below potential due to lockdowns. So, the RBI is maintaining a growth-supportive stance despite inflation rising above its comfort zone. But if Covid cases remain low, the economy could move to a more sustained growth trajectory. RBI could then shift its stance. “Over the next year or so, there may be a gradual uptick in interest rates as the RBI reduces the support it is providing and normalises policy, or at least prepares the market’s mindset,” says Joydeep Sen, corporate trainer (debt markets) and author.

According to Nevatia, as growth returns, the RBI would first withdraw the extra liquidity, which could also lead to interest rates inching up. “We expect the 10-year G-Sec to be in the 6.35-6.5 per cent range by the end of the financial year,” he says. Rate hikes, if required, may occur later.    

Safer strategies  

Shorter-term debt funds with portfolio maturity up to one year are the safest bet. “The bonds in these portfolios mature faster and get reinvested at higher yields,” says R Sivakumar, head – fixed income, Axis Mutual Fund. Conservative investors, who desire low volatility, should stick to such funds.

These investors may also consider target maturity funds, which invest in G-Secs, state development loans (SDLs) and ‘AAA’-rated PSU bonds and, hence, carry very little credit risk. If investors hold them till maturity, they will get the portfolio yield at the time of purchase. These are suitable for investors whose investment horizon matches the maturity of these funds.

Riskier strategies

Investors who have a longer investm­e­nt horizon and the stomach for vola­t­ility may invest 10-20 per cent of their portf­o­lio in riskier strategies. Longer-duration funds will be volatile in a rising-rate scenario. “The re­i­n­vestment time is much further away for the bonds in these portfolios, and they suffer higher mark-to-market impact,” says Sivakumar.