The Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) on June 8, 2023, kept the policy repo rate unchanged at 6.50 per cent. In its meeting in April, it had also left it unchanged. Meanwhile, mutual fund experts have urged investors to opt for medium-duration funds, 5-7 years.
Since bond prices and interest rates have an inverse relationship, an increase in interest rates negatively affects the bond prices. When interest rates rise, bonds offering lower returns become less attractive, leading investors to shift towards higher-yielding instruments. This shift in investor preference causes the bonds’ market prices to fall, bringing yields close to other instruments. RBI has paused the interest rate hikes since the last two policy reviews. Falling inflation and the RBI guidance on lower inflation numbers in the coming quarters give hope to fund managers that the interest rate is near its peak and it may go down in the future.
Rajeev Radhakrishnan, CFA, chief investment officer, Fixed Income, SBI Mutual Fund, says, “A pause-restart cycle in global monetary policy-making is the risk that has come to the forefront in recent weeks. In this context, the RBI has rightly reemphasised the requirement to continue withdrawal of liquidity and more importantly stress on the midpoint inflation target of 4 per cent rather than take comfort from CPI falling within the target band.”
Radhakrishnan suggests that investors base their fixed income outlook on the concept of "peak policy rates" rather than anticipating immediate changes in the monetary cycle. He further notes that shifts in liquidity dynamics influenced by RBI policy choices will likely shape the trajectory of market yields in the near future.
Says Marzban Irani, CIO, Debt , LIC Mutual Fund, “We reiterate our views that investors should go as long as possible depending on risk appetite. Existing carry despite recent fall in yield continue to remain attractive and should not be missed out.” Irani recommends that investors consider medium to long-duration funds as a preferred investment option.
Pankaj Pathak, fund manager, Quantum mutual fund, also has the same view. “Going forward, we would expect bond yields to move up from current levels - pricing for uncertainty around the monsoon and inflation impact of higher than usual increase in minimum support prices for the kharif crops. Investors with 2-3 years holding period should take a medium term and can invest in dynamic bond funds as long term fixed income allocation. Investors with shorter holding period should stick to Liquid funds," says Pathak.
What Investors Should Keep In Mind?
Debt funds provide superior net-of-tax returns, thanks to their tax efficiency due to compounding benefits, the ability to set off losses. Additionally, debt funds generally offer better liquidity than fixed deposits, allowing for redemption within 24 to 48 hours without penalties. Currently, government securities (G-secs) offer high interest rates, and debt funds provide yields close to 8 per cent (gross) which are 200 basis points higher than in March 2022. Investors should keep in mind their financial objective, investment duration, and liquidity before deciding on investments in debt funds.