Confident of further interest rate cuts, fund managers across the industry have started hiking their average maturity in gilt funds. In the last six months, average maturity of gilt funds which was in the range of 7-9 years has risen to 15-20 years as on December, 2014.
Recently the Reserve Bank of India (RBI) cut repo rates by 25 basis points and many market participants believe this is the beginning of a new cycle of interest rate reduction. Fund managers say, almost unanimously, that India might see further cuts amounting to over 75 basis points in the current calendar year and fund managers have adjusted their portfolio to benefit from further cut in interest rates.
According to data from Value Research, funds such as Canara Robeco Dynamic Bond Fund-Regular Plan, DSP BlackRock Government Securities Fund, HDFC Gilt Fund-Long Term Plan and LIC Nomura MF Government Securities Funds are only a few among many which have hiked their average maturity in the range of 14-21 years. The prices of fixed income securities are governed by interest rates prevalent in the markets. Interest rates and price of fixed income securities are inversely proportional. The net asset value (NAV) of debt funds is affected by the change in interest rates. If interest rates fall, bond prices (and therefore fund NAVs ) rise to adjust to new yields and vice versa.
Killol Pandya, senior fund manager-debt at LIC Nomura MF says, “One rate cut is already behind us and there are expectations that we may see a slew of rates going forward. Most pessimistic participants predict 50 basis point rate cut, while most optimistic players are predicting 125 basis points . So it’s very clear that interest rates are on their way down. Given this scenario it is better to increase the average maturity in long term bonds funds.”
Typically, gilt funds invest in long term papers of government securities and have higher maturity than medium term bond funds. So they are best suited in a falling interest rate scenario.
“The 10 year benchmark government securities (G-Sec) yields which are trading at around 7.65% might further come down to 7.20-7.25% in the next six months, giving a huge advantage to long term bonds funds,” said senior fund manager of top fund house.
In the last six months the 10 year G-Sec yields has moved down from 8.5-8.6%. The sharp correction was backed by increasing expectations of a turn-around in the interest rate cycle. Not surprisingly, several funds which had increased their average maturity have benefitted in the past few months. Increasing the average maturity has led many gilt funds (both medium and long term) give returns in the range of 18-24% in the last one year.
By Chirag Madia