Park funds into debt schemes as yields have turned attractive: Experts

Tactical bets on longer-duration funds not advisable in the current scenario as rate cuts are not on the horizon

Consumer price index (CPI)-based inflation eased to 6.77 per cent in October compared to 7.41 per cent in September. Debt fund investors need to align their investment strategy with the more benign inflation outlook that is emerging.

Expectations from the RBI

According to experts, peak inflation is probably behind us. CPI-based inflation is likely to trend lower over the next six months.

“We expect the Reserve Bank of India (RBI) to go for a 35-basis-point hike in December and a 25-basis-point hike in February. It will probably take the repo rate to 6.5 per cent and then pause, while maintaining 75-100 basis points (bps) of real rate,” says Devang Shah, co-head, fixed income, Axis Mutual Fund.

Explaining the rationale behind the expected pause, Shah says: “Though inflation is showing a downward trend, it is still above the RBI's mandate of 4 per cent. CPI inflation is not likely to touch 4 per cent soon. It is likely to range between 5 and 5.5 per cent in the 2023-24 financial year, according to our estimates. With inflation at these levels, we don't see the repo rate going below 6.5 per cent.”

Attractive yields

Experts say a large part of the rate hike cycle is over. Unless there is another event that has a global financial impact, bond yields may not rise much from current levels.

Investors should consider allocating more to debt funds over the next three months as the net yield to maturity (YTM) of many categories have turned attractive and could improve a little further. Debt funds, if held for more than three years, score over fixed deposits due to the more favourable tax treatment.

Select fund based on horizon

Choose debt fund categories based on your time horizon and risk appetite.

“If the investor’s horizon is less than one year, he may consider parking his money in Ultra Short Duration Funds and Money Market Funds,” says Shah.

According to Vidya Bala, co-founder, Primeinvestor.in, “Investors with a timeframe of above one year and less than five years may invest in Short Duration Funds and Corporate Bond Funds.”

She also recommends investing in target maturity funds (TMFs) whose maturity dates align with the investor’s horizon. “If you hold these funds till maturity, your return will almost equal the net YTM at the time of entry. Currently TMFs maturing in 2027 are attractive,” says Bala.

Avoid tactical play in long-duration funds

Investors should only go for longer-duration funds if they have an adequate investment horizon. “If you are building a long-term portfolio of 10 years, then gilt funds with 10-year constant duration offer a good entry point currently. The only caveat is that you should be willing to tolerate some short-term pain because yields could move up a little, causing mark-to-market losses in them,” says Bala.

Tactical exposure to longer duration funds, with only a one year or so horizon, is not advisable. 

“The RBI is not expected to cut rates after February. It is expected to be on a long pause thereafter. Hence, investors may not get the benefit of rate cuts within the next six months to one year,” says Joydeep Sen, corporate trainer (debt markets) and author.

Credit risk funds can be avoided

The credit outlook of corporates has improved. But before investing in a credit risk fund, compare their net YTM (YTM minus expense ratio) with that of corporate bond funds and banking and PSU funds. While credit risk funds take exposure to AAA, AA, and A papers, the latter two categories invest in AAA papers only. 

“Taking extra risk in credit risk funds can be avoided unless the difference in net yield between credit risk funds on the one hand, and corporate bond funds and banking and PSU funds on the other, is adequate—in the range of 75-100 bps,” says Sen.

 Currently, direct plans of credit risk funds are offering an average net YTM of 6.97 per cent.