Long duration funds may not be the best option to invest in at the moment, with debt fund managers saying short and medium duration funds remain ideal at this juncture.
The central bank’s Monetary Policy Committee (MPC) last week kept the repo rate unchanged, retaining its ‘withdrawal of accommodation’ stance. The hawkish tone didn’t surprise the markets, thanks to inflation remaining the primary concern.
Consequently, analysts believe rate cuts are off the table till at least July 2024.
Fund managers had earlier said the time was ripe to enter fixed income and increase duration, with the expectation that interest rates had peaked. The view has hardly changed, with experts saying the high yields still make debt funds an attractive proposition.
“We continue to expect the Fed to ‘Pivot’ and start cutting rates in the first half of CY 2024. At the same time, we expect the RBI to cut rates by at least 50 bps in CY2024, starting April. Given the view, we advise investors to increase duration. Investors with an 18-month horizon could look at the Banking PSU Fund, Medium Term Fund, and Dynamic Funds,” says Deepak Agrawal, CIO (Debt), Kotak Mahindra AMC.
According to him, a fixed income portfolio with duration in the band of 3-5 years is ideal for investors.
The 10-year bond yield in India is hovering around the 7.2% mark.
Data from Value Research shows that medium-to-long duration funds, which have a timeframe of 4-7 years, have returned an average 4% over the last three years and 6.3% over the last one year. During the same period, short duration funds or those with a timeframe of 1-3 years, have returned an average 4.8% and 6.2%, respectively.
“From an investment standpoint, long duration is not a suitable asset class at this juncture. However, one can tactically trade duration if there is a sell-off in the market,” says Manish Banthia, CIO (Fixed Income), ICICI Prudential Mutual Fund.
The prevailing higher yields provided by the environment’s high inflation and rising interest rates has raised the appeal of fixed income as an asset class, he says.
While long-duration funds (of more than 5 years) are less in number, they show a category average return of 4% over the last six months. The average for the past year is over 8%, but most of the funds have been in existence for less than a year.
“We expect increased demand for accrual assets given stable macros and elevated interest rates. Floating rate bonds, too, may continue to see improved demand for their attractive spreads. We recommend shorter-duration schemes and dynamic duration schemes because they can actively manage instruments with various credit ratings and actively manage duration to handle interest-rate fluctuations,” Banthia added.
Dynamic bond funds are those that dynamically manage the bond duration. In these, the fund manager makes an assessment on the future direction of interest rates and bond yields, and accordingly adjusts the duration.
For instance, given that bonds of a higher duration will see maximum impact of a change in interest rates, the fund manager will shift to a longer duration if there is an expectation of rates reducing.
