Go with accrual funds as govt bond market is expected to remain volatile

Fixed deposit investors should go for short-term plans now, and be nimble enough to shift when rates go up further

The 10-year government bond yield has been very volatile in the past couple of months. From a low of 6.41 per cent on July 24, 2017, the benchmark yield rose all the way up to 7.78 per cent on March 6, 2018, before declining to 7.18 per cent on April 6. Since then it has risen once again to around 7.47 per cent. Investors need to pursue a carefully calibrated strategy for their fixed-income investments in a year when bond yields are expected to be volatile.  

What’s going on? Between July last year and early March this year, bond yields surged primarily on account of fears of higher inflation. These fears dissipated some time ago with consumer price index inflation rate printing lower than anticipated. Another factor driving yields up earlier was the heavy supply of bonds, both from central and state governments. Moreover, the portion of bonds that banks can keep in the hold-to-maturity (HTM) category has been reduced. With bond yields rising, and public sector banks flush with bonds, they were not purchasing more bonds since they would have to keep them in the mark-to-market category. On the international front, the US Federal Reserve is on the rate hiking path while other central banks are cutting back their liquidity infusion programmes.

The reduction in yield from the 7.78 per cent level was the result of a conscious effort on the part of the government and the Reserve Bank of India (RBI). The government decided to borrow less in the first half of the fiscal year. The RBI chipped in by allowing banks to spread their losses on their bond portfolios over four quarters. Next came the credit policy which was remarkably dovish, with the expected inflation being lowered, despite the central bank highlighting risks such as hardening oil prices and increase in minimum support prices (MSP) for agricultural products. “While the government and the regulator have delivered more than expectations, lack of risk appetite has led to lower demand at the end investor level, which is the key reasons for the volatility. This risk aversion has been further exacerbated due to geopolitical tensions and the recent rise in the oil prices,” says Amit Tripathi, CIO – fixed income investments, Reliance Mutual Fund.

Shortly after the monetary policy, bond yields began to rise again, the primary reason being the lack of buyers in the auctions. According to Abheek Barua, chief economist, HDFC Bank: “The dominant theme this year will be bond market volatility. Yields may come down in the next month or two if RBI announces liquidity infusion, and also because this is the slack season for credit offtake. But they could move up again as fundamental fears resurface.” 

Be ready for higher yields: Central government borrowing will be higher in the second half. State government borrowings too are likely to be heavier than anticipated. Geopolitical tensions could cause a further spike in oil prices. “The big driver for yields rising further could be the forthcoming elections, which could cause an overrun in government spending. The Budget commitment on MSPs is also significantly inflationary,” says Barua.

Don't play the duration game: As the government bond market is expected to remain volatile, investment advisors are recommending accrual funds. Choose funds that have the majority of their corpus in AAA and AA-rated papers and hold them for the long term. A part of your corpus may go into credit opportunity funds. “With the economy expected to do well, we will see more upgrades of corporate credit ratings. This is already happening. Credit opportunity funds will offer attractive returns,” says Sunil Sharma, CIO, Sanctum Wealth Management. Invest not more than 10-20 per cent of your debt portfolio in these as they can be risky.  

If you have moved recently from fixed deposits (FDs) to debt funds, or if your investment horizon is less than three years, try ultra-short term funds. They invest in short-tenure papers and are not affected much by interest-rate movements. Sharma says that such investors can also look at arbitrage funds if they want to invest for a year or more. Certified financial planner Pankaaj Maalde suggests locking into fixed maturity plans (FMPs) if your tenure is more than three years.

Be nimble with fixed deposits: Banks including the State Bank of India (SBI) have hiked their deposit rates recently. SBI is currently offering 6.40 per cent on its one-year deposit (6.90 per cent to senior citizens). Some banks like Karnataka Bank are offering as much as 7.10 per cent for this tenure. Conservative investors investing for six months to one year may opt for FDs. “Invest for a shorter tenure now. If interest rates move up further, then lock into higher rates for the longer term,” says Arvind A Rao, a Sebi-registered investor advisor.

Among other options, the Senior Citizen Saving Scheme (SCSS) pays 8.3 per cent; Pradhan Mantri Vaya Vandana Yojana from Life Insurance Corporation offers 8 per cent assured return for 10 years, and Sukanya Samriddhi Yojana offers 8.1 per cent. Next, the Public Provident Fund remains attractive with a tax-free return of 7.6 per cent. “The key to selecting fixed income instruments is to consider the investment tenure you have and the post-tax return you will get,” says Maalde.