For some time now, returns from bond funds have been muted, particularly long duration funds. On top of it, due to incidents of the recent past, there are concerns on the credit risk aspect of debt funds. Investors are concerned about what should be done now. The advice is, unless there is a cash flow requirement, there is no urgency to redeem. The argument Market / volatility risk and credit risk are part and parcel of debt funds.
For more than a year now, bond yields have been going up, i.e., prices have been coming down, due to various reasons. The market has taken note of multiple negative factors in the process of yields moving up, and it is about time that yield levels should stabilise. Nobody can call the peak or bottom of a market, hence there may still be some more scope of adverse movements. However, after a long negative phase, when the 10-year government bond yield rose from 6.4% in the middle of last year to more than 8%, the probability of further adverse movement is limited.
The regulators are doing their bit; the gross government borrowing programme for the second half has been reduced significantly and Reserve Bank of India (RBI) has announced OMO purchase of G-Secs for October. Coming to credit risk, it is an inherent feature of bonds. The situation seems grim, due to the headlines of companies defaulting, companies being taken to NCLT, a large company being downgraded sharply, etc.
Here again, the situation is not as bad, only that the unfortunate cases get magnified and the situation seems that much worse. On the marquee default case, the government has stepped in and changed the management of the company and hopefully, the company will turn the corner. Concept of accrual One difference between equity and debt funds is that in equity, returns come from price appreciation only, dividend yield being miniscule, say less than 2%.
In debt funds, most of the returns come from accrual and only a small component comes from price appreciation. Accrual refers to the coupon or interest earning on the securities, which in loose terms is represented by the Yield to maturity (YTM) of the portfolio. The portfolio YTM is the weighted average yield of all the instruments in the portfolio.
Over the last year or so, when bond prices have been coming down, yield level has been moving up, hence the accrual going forward will be at a higher level. This will lead to better returns. Unless bond yields continue to move up next year, which is less likely, returns from bond funds will be better over next year.
Interest rate view RBI maintains the neutral stance on policy rate formulation. It means, unless there is a compelling reason, they would not hike or reduce interest rates. They have already hiked the signal repo rate twice, by 0.25% each time, in June and August this year. The forthcoming policy review announcement being on October 5, it may be decisive for the market on where interest rates are likely headed.
The RBI monetary policy committee may increase repo rate by 0.25%, or leave rates unchanged, and/or change the guidance on policy rates from neutral. If RBI maintains the neutral policy rate stance, even if it hikes rates, yield levels are likely to remain stable. This, in a way, is a positive for your bond fund holdings, as there would not be further adverse impact on interest rates moving up and accrual rates being better than earlier. If RBI changes stance from neutral to hawkish, i.e., a bias towards rate hikes, it will be adverse but that is less likely. Conclusion You should not churn your portfolio on every market movement. The current backdrop is one such context.