The Double Whammy To Bond Yields And Its Impact On Debt Mutual Funds
Nov 11, 2019

Author: Divya Grover

The Double Whammy to Bond Yields and Its Impact on Debt Mutual Funds
(Image Source: photo created by jannoon028 - www.freepik.com )

Fitch Ratings has warned that the Indian economy is in for `nasty couple of years' as it cut India's GDP growth projection to 5.5% for FY 2020. The agency said that lack of credit flow due to liquidity crunch in the NBFC sector has stifled the GDP growth.

The credit flow has been impacted sharply after the collapse of two major shadow bankers - IL&FS and DHFL. This in turn had a negative effect on auto and real estate sectors.

Meanwhile, global rating agency Moody's lowered India's credit rating from stable to negative, though it affirmed Baa2 long-term sovereign rating. In its report, Moody's cited increasing risks to the country's economic growth, partly due to lower government and policy effectiveness in addressing economic weakness.

India's GDP growth touched a six-year low of 5% in the June 2019 quarter due to weak agricultural and industrial output, rising unemployment and low income, liquidity crunch in the NBFC sector, among other factors.

The lack of any visible improvement till now as a result of various reforms and policies announced by the government and poor transmission of monetary policy mean that India's growth will continue to be tepid in the near term. This could weigh heavily on the country's revenue.

GST collection continued to be below the government's target of Rs 1 lakh crore consecutively from August to October 2019. If the GST revenue continues to be muted on the back of low demand, it could put additional burden on the government's finances.

The government took a bold move to slash corporate tax rate in an effort to address the slowdown in private consumption. While the move is a big relief to the corporates, it is estimated that it could cause a revenue loss of Rs 1.45 lakh crore to the government.

The government is already dealing with high fiscal burden even after accounting RBI's surplus transfer of Rs 1.76 lakh crore.

As per the data released by the Controller General of Accounts, India's fiscal deficit was Rs 6.52 trillion (92.6% of the budgeted estimate) at the end of September 2019. The government aims to restrict the deficit at Rs 7.03 trillion (3.3% of the GDP). Lower revenue collection due to weak economic growth and corporate tax rate cut may cause the government to miss its fiscal deficit target.

The 10-year G-sec yield inched up in the past three months, i.e. August to October on fiscal deficit concerns and lack of credit flow. However, on a year-to-date basis, the benchmark yield is down by 87 bps because of consecutive rate cuts announced by the RBI and the accommodative stance adopted by it. This augurs well for debt mutual funds as NAV of schemes inch up when the yield goes down.

[Read: How Slashing Corporate Tax Rate Will Impact Bond Yields? Know Here...]

Investment strategy to be adopted...

Since February 2019, the RBI has reduced policy rates by 135 bps to boost economic growth. The future policy rate actions will depend mainly on inflation data.

Though retail inflation moved to 14-month high of 3.99% in the month of September on the back of higher food inflation, it is still within RBI's comfort range. This provides further headroom of perhaps 25 bps rate cut in the upcoming monetary policy meet scheduled in December 2019.

But a further rate cut may not be in the best interest of depositors in a developing economy like India. Therefore, we may be in the last leg of the rate cut cycle.

Debt mutual funds that invest at the longer end of the yield curve like medium-to-long duration funds, long-duration funds, Gilt Funds, and Dynamic Bond Funds have delivered double-digit returns since RBI started reducing rates. But going forward, the gain in these categories may be limited.

Thus, investing aggressively at the longer end of the yield curve could prove less rewarding and risky (may encounter high volatility) in the foreseeable future. You would be better off deploying your hard-earned money in shorter duration debt mutual funds.

Nevertheless, if you wish to take the risk and exposure at the longer end of the yield curve, consider dynamic style funds that have the flexibility to move across maturities of debt papers as per the interest rate scenario.

Investing in debt funds is not risk free. You should consider your financial goals, risk appetite, investment horizon and liquidity requirements before investing in debt funds.

[Read: Approach Debt Funds With Your Eyes Wide Open...]

In the recent past, many debt funds across maturity profiles had exposure to downgraded and toxic debt papers exposing investors to investment unanticipated risk. Thus approach debt funds with your eyes wide open. Invest in schemes offered by process-driven fund houses.

One should analyse the schemes on quantitative and qualitative parameters and take into consideration interest rate and credit risk involved while investing in debt funds.

PS: If you want to add winning and the best mutual fund schemes to your investment portfolio, subscribe to PersonalFN's unbiased premium research service, FundSelect. With this you also get a complementary access to Debt Select.

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Graph 3: Risk-return spectrum

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Comments
prabha.tibrewal98@gmail.com
Nov 17, 2019

Very interesting
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