Fixed Income: Go for Debt Funds with Shorter Duration Profiles

With interest rates set to rise due to soaring inflation, retail investors will necessarily need to modify their portfolio of existing debt funds and plan new investments according to the time horizon. When interest rates rise, the value of existing investments in debt funds decreases because investors then prefer to invest in a fund with higher rates.

Analysts expect the Reserve Bank of India (RBI) to hike repo rates by 100 basis points in the current fiscal year. In fact, the bond market is pricing in a 200 basis point rise in the repo rate over the next two years, with terminal repo rates at 6%. One-year bond yields are trading in a range of 5.10-5.20% and two-year rates are trading in a range of 5.80-5.90%.

Debt fund strategy

Murthy Nagarajan, head of fixed income, Tata Mutual Fund, says that up to a month investors should be in a very short-term bond fund, a month to three months in a money market fund, four to six months in a floating rate fund and more than a year in bank funds and PSU, corporate bond funds. “If investors have a three-year time horizon, they can invest in five-year constant maturity funds, income funds, and gilt funds to take advantage of the indexing and higher accruals of these funds,” says- he.

Similarly, Devang Shah, Co-Head, Fixed Income, Axis Mutual Fund, says that for short-term parking solutions, investors can consider very short-term and money market programs. “Investors looking to the medium term can consider credit funds and those with a long-term investment horizon can consider target maturity funds maturing in 2027 and beyond,” he says.

In a rising rate scenario, investors may turn to floating rate funds, as these funds can switch to new issue securities with higher interest rates and older ones are automatically replenished. “Ideal funds would be liquid, cash, or even floating rate in this type of scenario to avoid losses or volatility in the fixed income industry,” says Santosh Joseph, founder of Germinate Investor Services LLP.

Rising bond yields

Bond yields have risen more than 100 basis points over the past 10 months and, at current levels, much of the potential repo rate hikes are already priced in. Pankaj Pathak, Fund Manager, Fixed Income, Quantum AMC, says cautious investors should stick to short-term debt categories such as cash and money market funds which tend to benefit from rising interest rates. ‘interest. “Investors with a longer time horizon and higher risk tolerance can turn to aggressive bond funds that have the flexibility to react to changing macro environments,” he says.

Refine your portfolio

While bond yields at this point have factored in most of the negatives, there could be some volatility due to the ongoing conflict between Russia and Ukraine. “The investors’ portfolio should be more oriented towards funds with a maturity of less than two years. Investors should reduce exposure to funds with an average maturity greater than five years in their portfolio, unless they have a time horizon of more than three years,” says Nagarajan.

Reinvestment risks

The risk of reinvestment in a rising interest rate scenario is that the investor will not be able to get the most out of it until the entire cycle of rising rates is over. Once investors believe the interest rate cycle has peaked, it would be best to switch to medium to long term duration funds, but until then it will be best to be at the bottom of the curve.


* For an investment of up to one month, opt for a very short-term bond fund
* For an investment of one month to three months, opt for a monetary fund
* The bond market expects the repo rate to rise by 200 basis points over the next two years, with terminal repo rates at 6%. One-year bond yields are trading in the 5.10-5.20% range
*Floating rate funds may switch to new issues of securities with higher rates
*Those with a long-term horizon may consider target maturity funds

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