Not time yet to take duration risk as G-Sec yield softening could reverse

After maintaining low-average maturity across portfolios for the greater part of 2018, fund managers have started raising it in their dynamic and longer-duration funds over the past couple of months. The median average maturity for dynamic bond funds stood at 6.41 per cent in January. It fell to 3.15 per cent in September, then inched up to 4.19 per cent by November end. 
 

Interest rates have also softened. From a 52-week high of 8.23 per cent, the 10-year government securities (G-Sec) yield has softened to around 7.29 per cent. All this raises the question of whether this is an opportune time for retail investors to take duration risk in their portfolios. 

A combination of global and local factors is responsible for the softening of the benchmark yield. After touching $85 a barrel, the crude oil price has now moderated to around $54. Also, concerns regarding a synchronised global slowdown are growing. "Most global market participants think that the major central banks are unlikely to tighten policy aggressively from here onward," says Suyash Choudhary, head-fixed income at IDFC Mutual Fund.

Among local factors, the Consumer Price Index (CPI) based inflation trajectory has been below expectation owing to subdued food inflation. In its December monetary policy, the Reserve Bank of India (RBI) revised its inflation forecast downward. "Market participants now believe that if inflation stays low, there is even the possibility of a rate cut down the line," says Akhil Mittal, senior fund manager at Tata Mutual Fund.  

RBI has also turned proactive on the liquidity front and has been conducting open market operations (OMOs) at an aggressive pace. If it continues at the current rate, it could purchase bonds worth Rs 3-3.5 trillion in this financial year — a massive number. This has altered the demand-supply dynamics for government bonds. Moreover, the Monetary Policy Committee has refused to use interest rates for currency defence, and instead chosen to focus on CPI inflation.

Because of all these factors, fund managers began to raise the average maturity of their portfolios some time ago (see table). They, however, say there is no guarantee that interest rates will continue to decline. The risk of a reversal exists, one of them being crude. "Once production cutbacks by the Organisation of Petroleum Exporting Countries (Opec) begin, crude prices could pull back," says Mittal.  

CPI inflation is low chiefly on account of soft food inflation. Core inflation still remains elevated. If food inflation increases, CPI inflation could also rebound.  

Moreover, there are concerns on the fiscal front. GST collections have been below the budgeted amount. With the Lok Sabha elections around the corner, one could witness an epidemic of farm loan waivers and rural income generation schemes, which could add to the fiscal stress.   

Most fund managers are of the view that investors should avoid duration risk at this point. "If you are already invested in long-duration funds, you may have made some returns. But this is definitely not a good point to enter long-duration funds," says Mittal. Corporate borrowing rates remain high, so the yield to maturity of lower duration funds remains decent, and investors can earn good returns from them, he says. 

According to Mahendra Jajoo, head of fixed income, Mirae Asset Global Investments, "Retail investors and their advisors should avoid taking opportunistic duration calls in fixed-income portfolios. If they invest in dynamic bond funds, it should be a long-term asset allocation call." Choudhary has similar advice: "The bulk of a retail investor's fixed income allocation should be made to AAA-oriented short-term and medium-term funds. If you are contemplating exposure to a dynamic bond fund, keep it in the same bucket as tax-free bonds, and hold it for the long term."