Long-duration funds strong despite rate hikes

Debt mutual funds (MFs) have taken centre stage since the removal of indexation benefit earlier this year. However, they have been impacted since the Reserve Bank of India started hiking interest rates last year. The central bank has hiked the repo rate by 250 bps since May 2022, taking it from 4% to 6.5%.

Investors usually steer clear of long-duration debt funds in a rising rate scenario as yields fall. This leads to higher bets on funds of shorter durations, as investors wait to ride out the interest rate storm.

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However, data suggest long-duration funds (11.15%) and Gilt funds with 10-year constant duration (9.75%) have given better returns than other categories over the past one year.

Long-duration funds are still an attractive proposition, say industry experts, and an extended rate hike pause will make it sweeter. They say investors only stand to benefit.

“We expect yields to move in a range with a positive bias for the next two-three months, as the RBI keeps rate hikes on hold,” says Sandeep Yadav, head (fixed income), DSP Mutual Fund.

Industry executives seem confident that the RBI is done with rate hikes, and yields may either remain at current levels or reduce, which investors will keep in mind.

Rajeev Radhakrishnan, CIO (fixed income), SBI MF, says: “The expectation of a forward-looking CPI around 5% and nominal yields — even on short-term sovereign assets — closer to 7% gives visibility on real returns closer to 2%.”

According to AMFI data, Gilt funds with 10-year constant duration had registered a net inflow of Rs 2,940 crore from May 2022 to April 2023. Similarly, long-duration funds saw inflows of Rs 6,162 crore during the same period.

As of Friday, the 10-year bond yield stood at 6.98%.

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“With the current forecast of 5.2% for inflation for FY24 and the 1-year T-Bill offering a yield of 6.9%, investors are getting a real rate of return of 1.7% at current levels for a period of one year, with sovereign exposure. With RBI expected to hold at current levels beyond December, markets could react in the short term, pushing yields upwards. But the real rate of return would remain attractive as inflation outlook remains benign,” says Amandeep Chopra, group president and head (fixed income), UTI AMC.

As regards long-duration funds, March alone accounted for Rs 4,675 crore of inflows, as investors rushed to take advantage of the indexation benefit in the final week before its withdrawal. However, the advantages of debt MFs vis-à-vis other fixed income instruments remain.

Chopra says benefits such as liquidity, diversification, transparency, and flexibility in risk and tenor to suit an investor, besides the opportunity to capture the upside from interest rate cycles, all remain intact.

This is what should make investors stick to debt funds of longer duration, instead of taking a negative view after the indexation removal, the industry points out.

Economists have, as per Bloomberg, estimated a 50-75 bps cut over the next 12 months. This, say experts, makes the time ripe for putting in money.

“Historically, investing in debt funds at the peak of interest rates has been hugely beneficial in terms of returns and capital preservation. We expect a prolonged pause, before rates likely start moving down in the first quarter of 2024,” says Arun Srinivasan, head (fixed income), ICICI Prudential Life Insurance..

Debt mutual funds (MFs) have taken centre stage since the removal of indexation benefit earlier this year. 

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