Long-term bond funds to benefit as rates decline further

With inflation embarking upon a downward trajectory and expectations of another 50 to 75-basis point rate cut, Rahul Goswami, chief investment officer of fixed income at ICICI Prudential Asset Management Company continues to run overweight durations at this point of time. In an interview with Chirag Madia, he adds that oil prices at elevated levels has the potential to become a negative trigger for the overall economy and investors can benefit from bond funds with a higher maturity and duration funds seem better placed in a downward rate cycle. Excerpts
Given the current backdrop, what are your expectations from the forthcoming monetary policy?

We believe average inflation is likely to settle at around 5% but there could be some sharp movements due to the base effect. With the Reserve Bank of India (RBI) having a bias of 150-200 basis points (100 basis points=1%) on real rates, RBI policy rates could be brought down to the 6.75-7% range. Therefore, it is likely that RBI will cut rates by 50-75 basis points throughout the financial year, while maintaining their stance on growth.

Where do you see the benchmark bond yields, currently close to 7.9%, settling?

If inflation expectations moderate further, market may start to price in further rate cuts in which case we may see yields of 10-year government securities (G-Sec) going below 7.25%. But as of now, with inflation averaging at 5% for the year, steady growth and stable monsoon, yields could settle at around 7.35-7.60% levels in the current financial year.

In such scenario, what is your overall investment strategy?

Given the current macro-economic fundamentals, we believe interest rates are at an elevated level. If average inflation remains in the range of 4-5% over next six to eight quarters, fiscal consolidation continues, credit demand remains low and currency stays stable, there is a likelihood that RBI will moderate its monetary policy stance and interest rates will remain on a downward trajectory. We continue to run overweight durations. Therefore, for our long-term bond funds we are running high maturities in products like ICICI Prudential Long Term Gilt Fund and ICICI Prudential Income Plan. In case of our short term income funds, we are running marginally overweight on duration. We believe that there is an opportunity for bond investors to ride the high maturity and benefit from potential gains by investing in long maturity bond funds including income & gilt funds.

As a debt fund manager what would be your biggest concern?

As far as India is concerned, oil prices at elevated levels can have a negative impact on the overall economy. A sudden spike in oil prices will be bad news for inflation, which will pose a challenge. Though domestically we are well placed, a likelihood of rapid interest rate hikes in US might also create unwarranted volatility in the bond yields. We are also keenly monitoring how the monsoon season pans out.

What kind of strategy should retail investors adopt at this point of time?

Bond funds with a higher maturity & duration funds seem better placed in a downward interest rate cycle. But for those looking to diversify, a debt portfolio with short- and medium-term bond funds can be a good combination as well. The time is opportune to invest in such products that can benefit in a  falling interest rate scenario and also limit the re-investment risk.

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