It's not the time to play duration game; existing investors should shift
If the exit load is not high, redeem investments from dynamic bond funds and gilt funds, and invest in shorter-duration schemes
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This calender year has been disappointing for debt investors. Some of them have even lost money due to volatility in the bond market. In the current interest-rate scenario, investors should put fresh money only in shorter-duration schemes. Existing investors should also move to a shorter-duration fund or credit opportunities funds to avoid further losses in longer-duration funds.
No relief in sight: The benchmark 10-year government security yield is on a secular upside and has increased in nine out of the past ten months. The benchmark yield was at 6.40 per cent in July 2017 and is currently at 7.79 per cent. AAA corporate bond yields too have risen sharply.
The Monetary Policy Committee (MPC) of the RBI also increased the repo rate (the rate at which the central bank offers short-term credit to banks) to 6.25 per cent. The MPC, however, maintained a neutral stance. The decision to hike rate was taken against the backdrop of firming core-inflation and sharp rise in the price of crude oil.
From here bond yields may react to a number of key macro variables, like the extent of rise in crude oil price, inflation, and the monsoon. But for the Indian bond market, one factor that is causing havoc to pricing is the scanty appetite of commercial banks for debt papers. The treasuries of these banks have lost billions of rupees in mark-to-market valuation over the past ten months and are hence shying away from taking fresh positions.
Further exacerbating the problem is rate hikes by the US Fed. It is impelling foreign institutional investors (FIIs) to sell rupee-denominated bonds. Between January and June 2018, FIIs have withdrawn Rs 414.34 billion from the Indian debt market, which is in stark contrast to their net inflows worth Rs 1.49 trillion in the Indian market during 2017. As selling is significantly more than buying, not only are bond yields moving up, there is also a significant amount of foreign currency outflow from the country. This is a key factor besides the spike in oil prices that has made the rupee the worst performing currency in Asia in 2018. All these factors combined are imposing upward pressure on bond yields.
We have seen a secular rise in yields for the past ten months. It is difficult to predict when and at what levels yields will stop rising and when they will turn around. As the gap between ‘bond yields’ and ‘equity earning to market capitalisation’ is widening, bonds with a shorter duration - those having a maturity up to two to three years - have started offering some value.
Avoid funds that play duration:
It is not the time to play the duration game as yields remain volatile and may move higher up to compensate for changes in macro variables. Also, given that we are in a rising yield environment globally, duration is something that investors should stay away from.
Usually, a debt fund that invests in central government dated securities plays on duration. These funds are categorised under ‘medium and long duration gilt fund’ by the Securities and Exchange Board of India’s (SEBI’s) circular on Categorisation and Rationalization of Mutual Fund Schemes. Dynamic bond funds also invest in instruments across duration, and investors should avoid these funds for the time being.
Existing investors should shift:
Investors in dynamic bond funds and gilt schemes would have already lost money over the past one year. If an investor holds a fund with a duration of, say, eight years, in case of a 25 basis points increase in rates, the fund value may decline by 2 per cent (approximately). For existing investors, it may be prudent to redeem their current investments in gilt or dynamic schemes and invest it in short-term funds, if the exit load is not very high.
No relief in sight: The benchmark 10-year government security yield is on a secular upside and has increased in nine out of the past ten months. The benchmark yield was at 6.40 per cent in July 2017 and is currently at 7.79 per cent. AAA corporate bond yields too have risen sharply.
The Monetary Policy Committee (MPC) of the RBI also increased the repo rate (the rate at which the central bank offers short-term credit to banks) to 6.25 per cent. The MPC, however, maintained a neutral stance. The decision to hike rate was taken against the backdrop of firming core-inflation and sharp rise in the price of crude oil.
From here bond yields may react to a number of key macro variables, like the extent of rise in crude oil price, inflation, and the monsoon. But for the Indian bond market, one factor that is causing havoc to pricing is the scanty appetite of commercial banks for debt papers. The treasuries of these banks have lost billions of rupees in mark-to-market valuation over the past ten months and are hence shying away from taking fresh positions.
Further exacerbating the problem is rate hikes by the US Fed. It is impelling foreign institutional investors (FIIs) to sell rupee-denominated bonds. Between January and June 2018, FIIs have withdrawn Rs 414.34 billion from the Indian debt market, which is in stark contrast to their net inflows worth Rs 1.49 trillion in the Indian market during 2017. As selling is significantly more than buying, not only are bond yields moving up, there is also a significant amount of foreign currency outflow from the country. This is a key factor besides the spike in oil prices that has made the rupee the worst performing currency in Asia in 2018. All these factors combined are imposing upward pressure on bond yields.
We have seen a secular rise in yields for the past ten months. It is difficult to predict when and at what levels yields will stop rising and when they will turn around. As the gap between ‘bond yields’ and ‘equity earning to market capitalisation’ is widening, bonds with a shorter duration - those having a maturity up to two to three years - have started offering some value.
Avoid funds that play duration:
It is not the time to play the duration game as yields remain volatile and may move higher up to compensate for changes in macro variables. Also, given that we are in a rising yield environment globally, duration is something that investors should stay away from.
Usually, a debt fund that invests in central government dated securities plays on duration. These funds are categorised under ‘medium and long duration gilt fund’ by the Securities and Exchange Board of India’s (SEBI’s) circular on Categorisation and Rationalization of Mutual Fund Schemes. Dynamic bond funds also invest in instruments across duration, and investors should avoid these funds for the time being.
Existing investors should shift:
Investors in dynamic bond funds and gilt schemes would have already lost money over the past one year. If an investor holds a fund with a duration of, say, eight years, in case of a 25 basis points increase in rates, the fund value may decline by 2 per cent (approximately). For existing investors, it may be prudent to redeem their current investments in gilt or dynamic schemes and invest it in short-term funds, if the exit load is not very high.