Big bond funds managers in India argue that long-term rates going down

By Khushi Malhotra and Subhadip Sircar
 

Some of India’s biggest bond fund managers say the nation’s interest rates are set for a long-term decline, ushering in a new investment era for the $1.3 trillion government debt market.
 

Bandhan AMC, Kotak Mahindra Asset Management Co. and DSP Investment Managers Pvt. are among those arguing that improving economic and fiscal conditions will lead to a structural decline in interest rates. As a result, the bulk of their debt funds are in bonds with 30 years or more in maturity to position for a bull market. 

The playbook rests on bets that the days of profligate government spending and large current account deficits are over, along with expectations that the central bank will contain inflation in one of the world’s fast-growing economies. Prime Minister Narendra Modi’s latest budget, for which traders had feared he would compromise after an election setback, reinforced a commitment to cut the fiscal deficit.

 

Buying 30-year bonds “is probably the best way to express a structural view on India’s fixed income,” said Suyash Choudhary, head of fixed income at Bandhan AMC. “Our view on the budget is that anyone doubting the ongoing policy commitment to macro stability should no longer be doing so.”

The government wants to reduce the deficit to 4.5 per cent in the next fiscal year, from a high of 9.2 per cent during the pandemic. New Delhi aims to subsequently ensure that borrowings will be on a declining path as a proportion of the gross domestic product, Finance Minister Nirmala Sitharaman said.

Yields on 30-year bonds have dropped more than 40 basis points this year to 7.04 per cent on Friday. According to the median forecast of economists surveyed by Bloomberg, the Reserve Bank of India’s policy rate will decline by 50 basis points to 6 per cent by the first quarter of 2025. The average in the past two decades is around 6.5 per cent.

The trade goes against the popular strategy in other markets, where investors betting on rate cuts and a normalisation of the yield curve are piling into shorter-term debt, while selling the longer bonds.

Part of the rally has been driven by higher demand for longer-maturity bonds from insurance companies and pension funds. Foreigners buying the debt after JPMorgan Chase & Co. added the bonds to its emerging-market index also supported the demand-supply dynamic, according to Invesco Asset Management India, which estimates overseas funds to absorb about 15 per cent of the supply this year.

“Some things turned out right, like the rapid fiscal consolidation,” said Vikas Garg, head of fixed income at Invesco Asset Management (India) Pvt. “Other domestic fundamental factors remain strong which have been providing resilience against global uncertainty.”

Foreign investors, who traditionally own shorter bonds, have been buying longer tenors since the index inclusion. Maturities of 10 years or more accounted for 23.5% of their holdings of the fully-accessible route — or FAR — bonds in the past month, calculations by Bloomberg based on Clearing Corporation of India data showed. That’s up 1.7 percentage points from the previous month.

Crowded trade
 

It’s too early to hold such conviction on lower longer-term bond yields and policy rates, others including ICICI Prudential Asset Management Co, Tata Asset Management Pvt and Edelweiss Asset Management Ltd. said. There are too much expectations for rate cuts and hopes of increased purchases by foreign funds, they said.

“Foremost, I want to see when central banks actually shift the policy route and to what extent or what is the expected depth of the cut cycle,” said Akhil Mittal, a senior fund manager at Tata Asset Management. “I still stick to the view of no rate cuts either by the Fed, nor by India.”

A lack of liquidity for longer bonds is also a concern,  according to Edelweiss and SBI Asset. 

“I am more comfortable running a barbell there, which still maintains a reasonably large duration based on what view we have without necessarily exposing the portfolio to too much swings and liquidity risk,” said Rajeev Radhakrishnan, head of fixed income at SBI Asset. 

For now, though, the expectations for continued gains for debt with longer duration has flattened the yield curve, narrowing the spread between the 10-year and 30-year bonds to less than 10 basis points from over 100 basis points in 2020.

“We’re seeing that the long bond trade is a fundamental-driven story rather than a near-term rate-cut driven story,” said Abhishek Bisen, head of fixed income at Kotak Mahindra Asset Management. “So rate cuts will definitely help, but overall fundamentals are positive for bonds. There’s going to be a structural decline in bond yields.”