By Siddhant Mishra
The last two years have been disappointing on the returns front for debt funds. However, with most of the rate hike cycle behind and future rate hikes having been factored in by short-to-medium category of funds, the yield-to-maturity (YTM) of such categories are now attractive. Vikas Garg, head of Fixed Income at Invesco MF, tells Siddhant Mishra that one should not get paranoid and stay put in overnight funds. Edited excerpts:
How would you describe the interest rate cycle in India vis-á-vis the global trend?
Central banks globally had resorted to rate cuts following the pandemic to fight the disruption caused by the lockdown. The situation changed earlier this year, led by inflationary pressures in many countries. The US Fed started rate hikes in March, among the first to do so, having raised the rates by 375 bps so far; they may still undertake a 100-bps hike over the next 4 months.
India began rate cuts in 2019 itself. The pandemic only triggered further cuts, and we went to an all-time low of 4%. The shift came in May this year, and though we started rate hikes a bit late, they have largely been in line with the global markets. Even as the RBI has increased the repo by 190 bps so far, the peaking of rates is likely some time away, with another hike of 60-75 bps expected. I would say that two-thirds of the rate hike cycle may be over.
Are investors, both retail and HNI, moving towards debt as an asset class, given the volatility in equities? Which tenures are in favour?
Fixed income has always been a significant asset class for someone managing a bigger portfolio and looking to keep the risk profile of the portfolio in line with the risk capacity. Unfortunately, fixed income has seen volatility similar to asset classes like real estate, equities, and commodities, giving investors the impression that it’s sensible to stay away. Returns have also been sub-optimal over the past two years, led by tightening of monetary policies.
We believe most of the pain is behind us, and we don’t expect the volatility as seen in the past to continue for long. Therefore, now is a good time for both retail and HNI investors, as well as corporates, to look at fixed income in a positive way to lower the overall risk profile of their portfolios.
Most of the funds are now offering a YTM of up to 7.5%, and these funds are AAA or 100% G-Sec oriented with a duration of 1.0-1.5 years, and thus not high on interest rate risk. Thanks to the rate hikes, the absolute YTMs are looking attractive. For us, the 2-4 year segment by categories such as short-term bond fund, corporate bond fund, and banking PSU fund, look promising from a risk-reward perspective, with a YTM of 7.25-7.5% and tenure of up to 1.5 years.
Returns by debt funds have been underwhelming since two years. When is a trend reversal likely?
We are quite close to the inflection point. Since late 2020, rates had slumped owing to rate cuts by the RBI and high systemic liquidity. Since then, rates have jumped by almost 250 bps. Those who entered the segment at that time would have entered at the lowest level of YTM and been hit by the frequent rate hikes.
Now, the starting YTM is close to 7%, which is a good entry point. Plus, hereon, we don’t expect a huge mark-to-market hit on the investors’ portfolios. Hence, from now to March is a good entry point for investors on a spread-out basis. With some volatility still expected, it may not be the right time to put everything into fixed income, but stagger it between now and March. Overall, returns could be close to the YTM levels.
The rates will be higher for a longer period now, hence large part of the returns will be from the YTM and not from a significant M2M or capital gains opportunity.
Do you expect people to remain invested in short and ultra-short duration funds for now?
That should have been the play for the last year or so when rates were going up, when it would make sense to stay put in overnight or ultra-short duration funds. However, the interest rate yield curve has flattened and forward rate hikes have been adequately factored in by the short-to-medium category of funds.
From a risk-reward perspective, the two-four-year segment looks promising. Keeping the volatility in mind, one should not go too long on the duration front, but one needs not be paranoid to stay in overnight funds, which would have a YTM of 6%. Simply put, the overnight and liquid funds don’t capture in the forward rate hikes, hence their YTMs are much lower. But funds of a duration of one-two years, have factored in the future rate hikes, because of which their YTMs are more attractive.