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Nityanand Prabhu Executive Director & Business Head, LIC Mutual Fund Asset Management Ltd explains why 2022 May Turn Out To Be The Year Of Debt Fund

Financial markets have gone through series of impediments and a meaningful recovery may not be around the corner. Nevertheless, when looked at a longer-term horizon, equity market may continue to attract retail participations through SIP.

Nityanand Prabhu
Nityanand Prabhu

With RBI stepping into rate hike mode, Bond yields have suddenly caught momentum. India 10-year G-sec yield rallied since the breakout of Pandemic from 6% in July 2020 to 7.6% as on June 13th 2022 (Source: Bloomberg). This indicates that as the year unfolds, as bond yields are entering into its attractive range, debt funds are catching attention among investors. If this continues, 2022 could become the year of Debt Funds. 

Financial markets have gone through series of impediments and a meaningful recovery may not be around the corner. Nevertheless, when looked at a longer-term horizon, equity market may continue to attract retail participations through SIP. Historically equity has emerged as one of the asset classes (if not the only) to generate positive returns over inflation on a consistent basis. Equity markets may take few more quarters to roar back. Debt market on the other hand has caught attention lately with Central Banks across the globe tightening the rope of liquidity. 

What Investors may do? 

Our analysis has led us to believe that this may be the right time invest in long duration funds. Investing in such fund may not only help you lock your funds at reasonably attractive levels but may also offers you opportunity to ride the bond market rally, should yields correct from here. In 2021 LICMF was proactive in identifying the rate hikes well in advance and we brought down the duration of our long duration funds to minimum thereby safeguarding investors wealth in rising interest rate scenario. We have now started increasing our durations to take advantage of the potential yield corrections. We expect another 75bps rate hike by Dec 2022. However, we also believe the same may have been factored in the current bond yield pricing, making current levels an attractive level to invest.  

If experts were to be believed, current bond yields may have factored in a large part of the future expected rate hikes. In order to understand this in deep we did an analysis by looking into historical data. The analysis revealed that, interest rates are a lag indicator while bond yields are leading indicator.  

Repo rate vs 10 year G-sec
Repo rate vs 10 year G-sec
  22nd May 2020  16th June 2022  Increase 
 Repo rate  4.00%  4.90%  90bps 
10 yr. G-Sec Yield 5.75%  7.60%  185bps

Bond yields are forward looking by nature. As evident from the above chart, 10-year G Sec touched its high in mid-July 2008 before the repo rates peaked in August 2008. Subsequently, yields started correcting in September 2008 well in advance before the repo rates came down. This phenomenon is seen in almost all the rate action periods. This might be the case today as well where repo rates have risen by 90 bps while bond yields have risen disproportionately by 175 bps.  

G-Sec Spread over Repo - A crucial indicator 

Interestingly the spread between the Repo rate and Interest rate may give us a directional indication. We did another analysis to look at the spread between G-Sec yield and Repo rate.  

G-Sec Spread over Repo - A crucial indicator
G-Sec Spread over Repo - A crucial indicator

It has been observed that sooner or later, the spread corrects and comes closer to its mean of 1.2%. Presently, the spread at 3.12% is close to its all-time high of 3.22% clocked during GFC (global financial crisis). Thus, it may be construed that we may have entered the fag end of the upward sloping yield curve and the yield correction might be round the corner. Investors may keep a close watch at the levels.  

Disclaimer: This disclaimer informs readers that the views, thoughts, and opinions expressed in the article belong solely to the author, and not necessarily to the author's employer, organization, committee or other group or individual. 

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY. 

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