Play it safe: Match your horizon with gilt fund's average maturity

From June 28, JP Morgan began including 27 Indian government securities (G-Secs) in its GBI-EM global index. This move will prompt international fund managers of passive funds to purchase these bonds. In the wake of this development, investors may consider investing in gilt funds, which invest in G-Secs.

Yields may decline

This is a positive development for the G-Sec market. “It could create around $25-30 billion of new additional demand for Indian G-Secs in this financial year,” says Akhil Mittal, senior fund manager-fixed income, Tata Asset Management.

In the interim Budget, the government had projected its net borrowing for FY25 at Rs 11.75 lakh crore. “Depending on the quantum of purchases by foreign portfolio investors (FPIs), an estimated 15 to 20 per cent of this amount will come from them during FY25,” says Joydeep Sen, corporate trainer (debt markets) and author. 

Longer maturity G-Secs will be included in the JP Morgan index. “This development will impact the longer end of the yield curve,” says  Ravi Saraogi, co-founder, Samasthiti Advisors. Mittal says it should lead to some softening of yields.

Be prepared for volatility

FPI flows are hot money. “At present, the Indian macroeconomic situation is positive on most counts. But if the Indian economy witnesses a slowdown, or interest rates in other geographies rise, a large outflow could put pressure on yields,” says Saraogi.

Some experts don’t think this is a major cause for worry. “Currently, FPI holding in G-Secs is 2-odd per cent. Even after additional purchases, it could rise to 4-5 per cent. In the event of a sudden outflow, there could be some near-term impact, but it won’t cause a big dent in the market,” says Sen.

Rate cuts could create alpha

Inflation is inching towards the Monetary Policy Committee’s (MPC) target and the fiscal deficit is under control. “Given these macroeconomic developments, the Reserve Bank of India (RBI) should be able to reduce the repo rate once inflation comes closer to target in the next 6-12 months, creating alpha in gilt funds,” says Mittal.

Food is the biggest contributor to the consumer price index (CPI)-based currently. “A normal monsoon and good agriculture production could lead to the food component coming within range, and softening of CPI-based inflation,” says Sen.

Rate cuts, expected to begin in the October-December or January-March quarter, are expected to be 50-75 basis points cumulatively.

Food inflation could play spoilsport

After the election results, the government could spend more to support agriculture and provide jobs. “Government spending could prevent inflation from softening. With GDP growth expected to remain strong, there may not be much scope for interest rates to fall,” says Saraogi.

A poor monsoon, persistent food inflation, or geopolitical risks could delay rate cuts.  

Should you invest?

Gilt funds don’t carry credit risk. By taking the mutual fund route, investors can take exposure to gilts with small amounts. Over a decade or more, returns from these funds tend to be sound. However, they tend to be volatile due to their relatively high duration.

“Investors with a horizon of at least 10 years, who can digest the interim volatility, may invest in them,” says Sen.

Saraogi warns against using them to take duration bets. “Getting duration calls right is very difficult,” he says. He suggests investing only if the gilt fund’s average maturity matches the investor’s horizon.