Moneycontrol PRO

Enhancing fixed income returns when the yield curve is flat is not easy, but there’s a way out

If you want to take a duration call at this juncture, choose your options wisely.

May 25, 2023 / 10:33 AM IST

Bond Investing

In an earlier column, I wrote that it is currently not advisable to take a duration call in long-maturity debt funds. A duration call is taking a view that interest rates are set to ease. This may happen on the RBI cutting rates or the market positioning itself for anticipated rate cuts.

The implication of a duration call is that you do not have an adequate investment horizon to come into a long-duration fund. Your objective is to benefit when interest rates in the market are coming down, and exit.

Getting opportunistic?

This is a quasi-opportunistic view. Since 20 April 2023, yields — the annualised returns you will receive on a bond — have eased in the mid-to-long maturity segments. That is, the scope for a further rally is limited now. At the current juncture, the yield curve is flat. The yield you will get on a 3-year maturity bond or 5-year maturity or 10-year one is similar. Usually, the longer the maturity of the bond or the bond fund, the higher the yield.

The question is, what do you do now to enhance your returns? One answer is to allocate to equity. While that is the preferred investment class, it is a function of your investment horizon and risk appetite. In the fixed income space, there is no issue in investing in long-maturity bond funds, but you should have an adequate horizon, roughly equal to the maturity or duration of the fund. If your horizon is not as long, it is better that you invest in a debt fund of appropriate portfolio maturity.

ALSO READ: Six charts that influenced SEBI’s mutual fund total expense ratio proposals

Against this backdrop, you may take limited credit risks. That is, rather than limiting yourself to AAA-oriented portfolios, you may come one step down the ladder to say AA. The arguments for this are (a) corporates have done a good job of deleveraging, ever since Covid days. Balance sheets are relatively lighter now on loans (b) the default cycle that happened earlier, starting with IL&FS, is over and the scenario is looking better (c) credit rating agencies’ upgrade to downgrade ratio is much better than earlier, vouching for improved corporate health.

How to enhance your fixed income return

Debt Mutual Fund portfolios with a mix of AAA and AA portfolios. In this, the carry yield i.e. rate at which interest accrues in the portfolio, will be relatively higher than a AAA-oriented portfolio. However, there is another aspect you have to bear in mind. There are recurring expenses charged to funds, and the net accrual level is net of expenses. You may compare the portfolio yield to maturity (YTM) — a data point available in the factsheet on the websites of fund houses — net of expenses, between AAA and mixed portfolios.

ALSO READ: Airmiles, lounge benefits, free hotel room: Credit cards line up goodies for summer holidays

The other option is to directly buy bonds. The bond market is not so liquid and usually out of reach for retail investors. However, the market and intermediation are expanding. There are bond houses, i.e., brokers / NBFCs that make corporate bonds available to high networth individuals (HNI) and mass affluent investors. There are wealth management entities that have direct bonds in the product bouquet. And these days, there are online bond platform providers (OBPPs) who offer their inventory of bonds on their websites.

ALSO READ: Passive investing gaining momentum but retail investors still have only a small share

In direct bonds, it is important to not just go by the yields available — the higher the yield, the higher is the compromise on the quality of the issuer company. Either you invest in AAA-rated bonds, or in non-AAA, e.g. AA-rated bonds, with due care. There are business houses with a proven track record and debt servicing history that are not rated AAA. As long as you have comfort with the “name” of the issuing company, i.e., its goodwill and track record, you can go for non-AAA issuers as well.

Keep the risks in mind

There are other fixed-income products with even higher carry yields that are just investment grade (rated higher than BBB). There are venture debt funds and stressed asset funds. In these, the default risk and returns are higher. It is advisable for retail and mass affluent investors to stick to a digestible level of risk. The higher-risk products are for HNIs with an understanding of and appetite for risk.

Joydeep Sen is a corporate trainer (debt markets) and author
first published: May 25, 2023 10:33 am