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Debt funds get a leg up from RBI’s liquidity infusion

As short-term bond and money market instruments yields fall, these investment options should do well

March 27, 2020 / 05:13 PM IST

Debt funds that were reeling under constant selling pressure of foreign institutions have got the much-needed relief from the RBI. The central bank has promised to unleash massive liquidity to ensure that the massive selling in the bond market does cause yields to rise and prices to fall. It also aims to improve the market sentiment. Debt funds may thus deliver reasonable risk-adjusted returns in the medium term.

How will liquidity help debt funds?

RBI has cut the repo rate by 75 basis points to 4.4 per cent and the cash reserve ratio by 100 basis points to 3 per cent with effect from 28 March 2020.

Kumaresh Ramakrishnan, Chief investment officer-fixed income, PGIM Asset Management Company, says, “A one percentage point cut in CRR will enable banks to release funds of around Rs 1.35 lakh crore. This can be lent or can be used to buy bonds. This should bring down interest rates.”

Yields too are expected to head south. R Sivakumar, head-fixed income, Axis AMC says, “The cut in the repo rate should immediately bring down the yields on money market instruments.” Liquid and low duration funds investing in money market instruments have witnessed losses in the last one week, as yields on these instruments had gone up. The yields are expected to decline and investors should benefit.


The RBI has also introduced a new tool that will help the corporate bond markets. This is the targeted long term repo operation (TLTRO). The amount involved is Rs 1 lakh crore. In this arrangement, banks would be encouraged to borrow for a three-year period at overnight rates. The liquidity so availed by banks should be used to purchase investment grade non-convertible debentures, bonds and commercial papers. “The objective of the TLTRO is to make banks purchase the investment grade bonds on the backdrop of a lot of stress seen in the past couple of weeks in the corporate bond market. Bank participation will increase liquidity and reduce yields on investment grade bonds,” says Sivakumar.

The funds that banks borrow in the LTRO must be used to buy corporate bonds. Such purchases are expected to push bond prices up and bring down yields. In turn, the net asset values of debt funds may improve.

“After RBI’s announcement, the yields on the three-year AAA-rated bonds went down by 125-150 basis points and one-year AAA-rated bonds saw yields crashing by 200-225 basis points,” says Kumaresh. “As we enter the new financial year and the additional funds released by the RBI announcement come to the system the difference between the overnight rate and AAA-rated bond yields, which currently stand at 200 basis points, should go down further,” he adds.

Where should you invest?

“Debt funds investing in bonds maturing in less than three years look attractive,” says Sivakumar. As short-term bond and money market instruments yields fall, these investment options should do well.

Vikram Dalal, MD, Synergee Capital says, “Bonds issued by public sector enterprises and select banks maturing within three years are attractive.” He recommends investments in banking and PSU bond funds focused on short maturity instruments. Investors can also consider the three-year option of the Bharat Bond ETF.

While the RBI has put its best foot forward, the situation is still tricky and investors need to be careful while investing in fixed income options. Look at your investment horizon first. Match your investment horizon with a debt fund that is best suited for it. Avoid credit risks. For shorter horizons, consider liquid and low-duration funds.

Dalal warns investors against taking exposure to long-term bonds as there is not much clarity on the quantum of damage caused by Covid-19 and the likely time it will take to revive the economy.
Nikhil Walavalkar
first published: Mar 27, 2020 05:06 pm
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