Short-term debt funds offer opportunities as yields rise

Mumbai: A spike in bond yields driven by elevated oil prices amid the West Asia tensions may have opened opportunities for investors in debt schemes, according to money managers. Short-term debt funds investing in bonds maturing over 2-3 years and schemes betting on long-term government securities are best poised to benefit from the higher yields, they said.

The yield on benchmark 10-year government bonds rose from 6.67% to 7.12% amid the war before easing to around 6.97% on April 9 on concerns the recent oil price surge would stoke inflation. While the Reserve Bank of India kept interest rates unchanged in its April monetary policy on Wednesday, following the US-Iran ceasefire, the likelihood of the central bank refraining from further easing could keep bond yields elevated.

“Markets have already sold off aggressively in anticipation of aggressive rate hikes,” says Devang Shah, head – Fixed Income, Axis Mutual Fund. “With RBI’s commitment to keeping system liquidity neutral to surplus and inflation well within RBI’s comfort zone, we expect a pause in interest rates for the next two policy meetings.”

Investors could allocate the bulk of their fixed income portfolio to corporate bond funds and short-term bond funds where the average maturity is 2-3 years, and yields are 7.5-7.6%, he said. Returns from bank fixed deposits with three-year maturity are in the range of 6.3 -6.5%.

Fund managers said RBI could raise repo rate – a key policy rate – by 25-50 basis points later in the year if inflationary pressures persist and bond yields remain higher. A rate increase would put pressure on bond prices, particularly for long-duration funds, reinforcing the case for investors to stay with shorter-maturity debt funds where the impact of rising rates is relatively limited. Investors with a higher risk appetite could consider gilt funds betting on long-term government securities if yields surge further.

“A tactical investment in the government bonds market can be considered as and when investor sentiment turns adverse and benchmark 10-year IGB yield trades in a 7-7.15% range from a technical perspective,” says Dhawal Dalal, president and CIO (Fixed Income), Edelweiss Mutual Fund.
According to Shah, investors could invest in schemes betting on government securities with 30-40-year maturities as and when yields rise above 7.75%. Currently, the yield on 30 -year bond is at 7.6% and on 40-year bond is at 7.62%.