Fixed-income investors with a 2-3 year investment horizon should consider allocating their surplus funds to Dynamic bond funds for higher yields, according to an expert.
“We suggest investors with a 2-3 years holding period should consider adding their allocation to dynamic bond funds to benefit from higher yields on medium to long-term bonds,” Pankaj Pathak, Fund Manager- Fixed Income, Quantum Mutual Fund wrote in the AMC’s Monthly Debt View for November 2022.
“Dynamic bond funds have the flexibility to change the portfolio positioning as per the evolving market conditions. This makes dynamic bond funds better suited for long-term investors in this volatile macro environment,” he added.
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For investors with shorter investment horizons and low-risk appetite, Pathak said they should stick with liquid funds. “With the increase in short-term interest rates, we should expect further improvement in potential returns from investments in liquid funds going forward.”
While the interest rate on bank saving accounts is not expected to increase quickly, returns from liquid funds are already seeing an increase, according to the expert. Therefore, investing in liquid funds looks more attractive for your surplus funds.
Which liquid fund to select?
Pathak suggested that investors with a short-term investment horizon and with little desire to take risks should invest in liquid funds which own government securities and not invest in private sector companies which carry lower liquidity and higher risk of capital loss in case of default.
According to the Monthly Debt Review by Quantum AMC, bond yields are expected to move sideways in a tight range with the 10-year G-sec yield trading between 7.2%-7.6%. While Short term money market rates will move higher along with the policy repo rate.
Pathak suggested investors should look for emerging opportunities in the bond market as the ‘peak of central banks’ hawkishness is now behind us.”
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“After the recent sell-off, bond valuations have improved. Currently, the 3-5 years government bonds are trading at a yield of between 7.30%-7.45%. This is more than 140 basis points above the repo rate of 5.9%. The long-term average of this spread in a tightening interest rate environment is around 80-90 basis points,” wrote Pathak.
“As the monetary policy stabilises, the yield spread between long-term bonds and the repo rate should compress. So, we see limited upside on yields from here. Even in terms of real interest rates, the entire bond yield curve is now trading at a yield above the expected CPI inflation,” he added.
Invest in quality bonds
Axis Securities wrote in its Multi-Asset Strategy report for November 2022 that more rate hikes may be expected in the upcoming RBI monetary policy meets. However, the quantum of hikes is expected to be lesser that the current one.
Axis Securities believes that “the yield curve would flatten further going ahead and the shorter end of the yield would move higher in H2FY23 as compared to the higher end of the yield. The higher end of the yield remains cautious due to policy normalization, higher inflation expectations, and the higher government-borrowing program for FY23.”
“We recommend a Quality approach for bonds with some non-AAA exposure based on risk appetite,” Axis Securities recommended.
(Disclaimer: Views expressed above are those of the respective commentators. Mutual fund investments are subject to market risks. Please consult your financial advisor before making any investment)
