Debt fund managers take active calls to risk-proof their portfolios

This comes even as most fund managers do not foresee rate hikes

Debt fund managers are deploying different strategies to shield their portfolios amid an uncertain interest rate scenario.

SBI Mutual Fund (MF) has been raising its cash holdings, while ICICI MF is betting on Government of India (GoI) floating rate bonds to take advantage of their attractive accruals.
 

Meanwhile, most of the fund managers remain bullish on the short-to-medium duration of the yield curve.

“Portfolio strategy, while being aligned with the fund templates, is based on the expectation that liquidity and monetary policy in India may remain tight in the near future.
 

That broadly involves a lower duration stance and adequate portfolio liquidity to be in a position to be flexible in the changing market landscape,” said Rajeev Radhakrishnan, chief investment officer (CIO), fixed income, SBI MF.

The fund house’s lower duration stance is evident from the dynamic bond fund portfolio. At the end of July 2023, the average duration of the portfolio stood at 3.9 years, lowest among the larger schemes.
 

Fixed income CIO of ICICI Prudential MF Manish Banthia is not expecting changes in the interest rate and is focusing on accruals to lift portfolio yields.
 

“We believe we are right now in a state of interest rate neutrality. In such a scenario, accruals become the main strategy. One of the instruments providing good accrual income in our various fixed income schemes is the GoI floater bonds. We have a sizable exposure to these instruments, which has helped us enhance the overall portfolio yield. Yields continue to remain attractive due to high accruals from GoI floater bonds,” he said.
 

The interest rate of GoI floating rate bonds is revised by the Reserve Bank of India (RBI) every six months based on the yields of the 182-day treasury bills. In May, the RBI had announced a 6.97 per cent interest rate for floating rate bonds 2024.

Fund managers said that while inflation has gone up, the RBI is unlikely to hike rates.

Suyash Choudhary, head, fixed income, Bandhan Asset Management Company (AMC) expects the RBI to be patient with the recent surge in food prices, considering its temporary nature and evolving growth outlook.

“Meanwhile, bond markets are already partly pricing in a rate hike, and the five-year government bond is currently at an adequate valuation cushion to the overnight rate. Thus, bond volatility may remain relatively contained. We continue to remain invested, preferring the three-to-six year maturity part of the curve,” he added.
 

Puneet Pal, head of fixed income at PGIM India MF, said the RBI may announce another rate hike only if inflation pressure emerges in the non-food segment as well.
 

“We were not expecting rate cuts this year and have been broadly maintaining a neutral duration stance over the last quarter. The current bout of high inflation is because of elevated food prices. We do not believe that the RBI will opt for a hike again unless there are other inflationary pressures,” he said.

Given the uncertainty around interest rates and a flat yield curve, most fund managers say schemes with short-to-medium duration and dynamic bond funds are better placed from a risk-reward perspective.

Some also say that sovereign bond (gilt) funds can also be a good long-term bet.

At the end of July, the average yield-to-maturity (YTM) of gilt funds was 7.25 per cent. In comparison, the riskiest debt schemes had a YTM of around 8 per cent. 

However, gilt fund yields are still similar to that of shorter-horizon schemes in the money market and short-term bond funds, which face lower interest rate risks.

However, since the rate hike cycle has most likely come to an end, investors with longer investment horizons can get better returns through gilt funds by way of capital appreciation. 

Since bond prices are inversely related to interest rates, any cut in rates by the RBI will lead to capital gains.

The price appreciation is higher for longer duration papers vis-a-vis shorter duration bonds.