With Bond Yields Going North, What Should You Do?

Recommend short term bond funds to your clients.

Over the last six months, the debt market has been quite volatile. There are many reasons for this volatility – chances of not meeting the fiscal deficit target of 3.2% of GDP, excess government borrowing, rise in inflation and lack of buying interest from banks.

Also, RBI has no or little room to cut key policy rate due to the fact that real interest rates are positive and output gap i.e. capacity utilisation in the economy is at the lower end.

Overall, 10-year benchmark G-Sec yield has moved up almost 1% from 6.4% in July 2017. Hence, many investors in debt funds have endured mediocre returns. So what now?

For existing investments in debt funds, there is no need to change the portfolio. So far, markets have discounted all the negatives. However, we cannot rule out further up-tick in yields as buying interest in the market is on the lower side. In addition, inflation is expected to be marginally higher than RBI’s central target of 4% and within the tolerance limit of 6%.

For fresh investments, we have to look for ways to take advantage of high yields. A simple, straightforward way of taking advantage of the current levels is to invest in fixed maturity plans (FMPs) or interval funds (IFs). There is no volatility risk on maturity of the product. Even if yields move up, it is only an opportunity loss, not a cash loss.

Short term bond funds are a safe bet, as volatility is relatively lower than long term bond funds / dynamic bond funds.

The other way of taking advantage of the prevailing situation is going contra with a risky bet. The overnight repo rate is 6% and the 10-year G-Sec yield is in the range of 7.3% – 7.4%, indicating a significant spread. In July 2017, when RBI repo rate was 6.25% and the 10-year benchmark gilt yield was 6.45%, there was hardly any spread. If yields move up, say 7.5% or 7.75%, the entry into income funds would be attractive if your clients can stomach some volatility. Well, if the last rate cut was on 2 Aug 2017, just compare the yields then and now. You will find a ‘discounted sale’ offer. Such a call would benefit your clients if there were any positive news flow such as lower fiscal deficit target and easing crude oil prices.


In my view, the current ‘discounted price’ levels are attractive. If you want to play it safe, go for open-ended short term bond funds or close ended FMPs. And if your clients can take risks,  start building positions in long bond funds.

Source: https://cafemutual.com/news/guestcolumn/324-with-bond-yields-going-north-what-should-you-do

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