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

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.

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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.

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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.

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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.