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Gilt fund or corporate bond fund? How to invest in debt funds post RBI money policy

Gilt fund or corporate bond fund? How to invest in debt funds post RBI money policy

08 Apr 2021

NEW DELHI: From fund managers to economists to bond market traders, everyone welcomed the decisions taken by the Monetary Policy Committee of the Reserve Bank of India.

In its money policy review on Wednesday, RBI also kept the general public’s interest in mind and batted for tax cuts on fuel. Key measures included a quarter-wise OMO calendar that is expected to help manage the yield curve and the massive borrowing program, with Rs 1 lakh crore scheduled for Q1 of FY 22. RBI expects inflation to rise marginally in FY22 though projects food inflation to soften.

Thanks to the steps taken by RBI, which included fund infusion in the market through various tools, yields on benchmark 10-year government papers came down by over 6 basis points.

This should cheer debt fund investors, as any drop in yields means net asset values (NAV) of funds will rise, as they are inversely related. But those who are not invested in debt funds could look at safer options and should keep their expectations low.

“The policy is supportive of interest rates at the long end, with some impact at the shorter end owing to longer tenor liquidity absorptions as part of the liquidity management program. We would continue to focus on Banking & PSU, Corporate Bond and Dynamic Bond fund categories post today’s policy,” said Kumaresh Ramakrishnan, CIO for Fixed Income at PGIM India Mutual Fund.

Financial planners say gilt funds and corporate bond funds can be a good bet for those having a longer-term investment horizon, while short-term debt funds are better suited for those with a 1 to 3-year horizon.

“G-Secs are good for more than three years. It still makes sense to be in short-term debt funds or low duration funds, because while they are saying the stance will remain accommodative, but at some stage, it will change if inflation remains high. So, there is no point in taking risk if I am invested for less than three years,” said Lovaii Navlakhi, Managing Director & CEO of International Money Matters.

Some analysts have warned investors not to expect the same high returns on debt funds that they earned in last three years, when interest rates were falling. But still, for those seeking safety, debt funds make sense.

“When the direction of interest rate is not clear — yields have been trying to climb up, but RBI is trying to keep them down — if you have a lower time frame, stick to ultra-short and short-term funds where yields have definitely gone up. Even for more than three-year periods, one should have a ladder strategy, i.e., hold some amount in ultra-short and short-term funds and rest in corporate bond funds, so any volatility can be curtailed,” said Vidya Bala, Founder of Prime Investor.

Short-term yields to rise

Short-term rates, however, are set to rise. It could have some negative impact on NAVs of the rate-sensitive funds that hold such securities initially. But eventually, as these funds add more higher rated coupons, they may be first to reap the rewards of higher yields.

“RBI measures should be able to counter the global adverse backdrop of upward movement in yields and higher commodity prices. The increase in long-term repo operations over 15 days could cause one-year yields to move up by 10 to 15 basis points and remain at those levels,” said Murthy Nagarajan, Head of Fixed Income at Tata Mutual Fund.

RBI has outlined a heavy borrowing programme, which has left many fund managers in wait and watch mode, as last few auctions have not gone down well and the bond market revolted after RBI tried to cap the yields on government papers.

“Given the heavy borrowing programme, it will be interesting to see how investors bid at the auctions, as they have lost money and global yields are on an upward trajectory. RBI has also stated that it does not have a specific yield level in mind, when it is doing OMO. So it will be on market players to determine the levels at which they are comfortable buying in these auctions,” Nagaraj said.

The first bimonthly monetary policy for financial year 2022 maintains status quo on all key policy rates. The MPC also reiterated an “accommodative stance” on rates and “surplus liquidity” to help the economy return to a durable growth path.

“Overall, there wasn’t much surprise or novelty in the monetary policy statement. RBI has chosen the wait-and-watch approach as the economy stabilises amid a heightened pandemic situation. We expect the fixed income market to follow suit, i.e. adopt a wait-and-watch approach with respect to the evolving liquidity and inflation situation,” said Unmesh Kulkarni, Managing Director and Senior Advisor, Julius Baer India.

He expects the 10-year G-sec to trade in the 5.9-6.3 per cent range in the near term. “Yields could see some short-term relief owing to pandemic risks to growth, but could see a fresh pickup in the second half of FY22 once the pandemic situation eases and the focus is back on economic recovery,” said Kulkarni.

Enquiry market: NBFC in focus

Analysts believe additional measures such as extension of on-tap TLTRO scheme and additional liquidity support of Rs 50,000 crore to Nabard, Sidbi and NHB are positive for smaller HFCs, NBFCs and MFIs.

“Key beneficiaries of these measures could be Can Fin Homes, Repco Home Finance, Home First Finance, Shriram City Union Finance and MFIs like Credit Access Grameen and Spandana Sphoorthy,” said Amar Ambani, Head of Research for Institutional Equities, YES Securities.