Most of the floating rate funds have outperformed liquid funds in the last 6 months

While the RBI is yet to hike the repo rate, yields on government securities have risen sharply over the past six months: yields on 10-year bonds range from 60-70 bps to 6.9%. Where are they going next year and what will be the key drivers?

Generally, long-term bond yields tend to outweigh RBI’s policy action as they are a function of evolving macro-economic fundamentals, while short-term yields depend more on RBI’s action in terms of liquidity and rate changes . Therefore, the market is expecting inflation and interest rates to rise. In India, there has been a perceptible rise in bond yields after the RBI discontinued the G-SAP (G-Sec Acquisition Program) in its mid-year policy. Therefore, because the RBI is no longer buying government securities and there is a steady supply of government securities, the returns have increased.

There was a lot of apprehension in the market following the Russia-Ukraine conflict, with crude oil prices rising and bond markets reacting to it. But, after the initial reaction, there is a certain sense of stability in the market for two reasons. One, the conflict has not become a widespread global conflict, and second, oil sanctions still exclude oil supplies from Russian companies. So, even this has helped. Therefore, people are expecting that this supply shock related oil price rise may not be very long term in nature. There have been speeches from monetary policy officials to the effect that this supply shock inflation is not something they can necessarily address and that they are asking the government for supply-side measures, tax exemptions and much higher oil prices. Hoping for growth. , So, while there has been a jump in returns after the struggle, but right now, they are in a stable range.

At the same time, we should appreciate that March has been a dormant month in terms of government bond supply. Last year’s lending program has been completed. So, once the new year’s lending program starts, we will know if there is any further jump in yields.

At this point, the only driver is the RBI as in the absence of its intervention, given the imminent recovery in the supply of bonds and price movements in the global environment and commodity basket, yields will rise. Therefore, RBI would like to moderate yields, therefore, it all depends on how much RBI feels the need to support growth. At this point, the central bank’s guidance is clear, focused on growth and confident of moderating inflation in the next quarter. Even if you consider the Russia Ukraine conflict, the revised inflation projection will be in the 5-5.5% band which is well within the RBI target of 4-6%. So, either if inflation picks up and global markets become volatile, RBI may have to step in. Therefore, the supply of bonds is a factor that will put pressure on yields. So, my understanding is that, there will be some practical pricing and therefore, I expect the yield to come down to 6.25 – 6.50% by June.

Which debt funds matter the most to investors today?

Right now, there is a lot of volatility and since everyone expects interest rates to rise, they are pushing out the short-end of the curve. Therefore, the yield curve is steep. So, while rates may go up next year, the opportunity cost of waiting and not investing is also very high. Target Maturity Funds (TMFs) are a good product and they provide predictable returns. It makes sense to invest in them now. There is another element as well. If you hold the money in short duration funds for a short period, you will be subject to tax at your income tax rates, whereas if you invest in TMFs for five years, the long term capital gains tax benefit is available. Therefore, there is a huge impact in terms of taxation.

Now, different people have different investment horizons and risk appetite. Hence, from the interest rate expectation point of view, short duration funds also provide a good option. Banking and PSU funds look good for 2-3 years if you want to take advantage of interest rate fluctuations.

Mirae Asset MF launched its first TMF only last week. Why the late entry into this relatively safe and popular category?

There is no such thing as late or early. One, if you look at the last one year, people were expecting rates to go up, but RBI has maintained a very stable interest rate environment to support growth. Now, there is a possibility that over an extended period, rates may remain high. So right now, is a good time to invest in TMF. Second, our Target Maturity New Fund offer was closed just ahead of the financial year to provide investors with an additional one year indexation benefit.

With companies delivering and economic activity returning to normal, is this a good time to take credit risk?

Right now, there is a certain amount of optimism on credit as Corporate India has delivered. However, challenges remain in the middle and bottom segment of the corporate sector due to formalization and digitization of businesses during COVID. Now that the economy is picking up, credit growth can happen and we have seen a growth of 8.5 per cent in the last one year. Personally, from a long-term perspective, I don’t think credit risk funds have the potential to outperform on a sustainable basis. In credit risk, there is a need to understand the dynamics of risk versus return in that category.

What is your view on floating rate funds in case of rising rates? Do they really outperform other funds, given that they largely invest in fixed rate debt papers and get their mandate through interest rate swaps?

No one can predict what will happen next. But if you look at the last six months till March 15, where short-term rates have gone up, most floating rate funds have outperformed liquid funds.

There is limited availability of floating rate bonds in India. When you are using overnight interest rate swaps, you are taking risk on a basis. So, for example, when we hedge, we expect that if corporate bond yields increase by 50 bps, their price will move in the opposite direction to the same extent. What can actually happen is, that the rates of cash bonds go up by 50 bps but swap rates go up by only 30 bps. This anomalous movement between the rate of a bond and a swap is called basis risk. Secondly, when you’re buying a bond and swapping against it, you’re getting a fixed rate on the bond and paying a fixed rate on the swap and getting a floating overnight rate. are. Effectively, you are holding an overnight fund. A dynamic bond fund does the same thing – when rates are rising, it will switch overnight and when rates are going down, it will move to corporate bonds. So, a floating fund is a dynamic bond fund in a separate packet.