On the basis of the current supply dynamic, a sharp and sustainable fall in yields looks unlikely from here
Suyash Choudhary, head-fixed income at IDFC Mutual Fund shares his views on how he sees bond yields moving following Reserve Bank of India's (RBI’s) announcement of a fresh Operation Twist, to facilitate the government's borrowing programme. In an interaction with Jash Kriplani of Moneycontrol, he gives views on where he sees smart trades on the yield curve. Excerpts.Where do you see the yields heading in the current environment?
We expect yields to remain range-bound. There is a Rs 20 trillion supply calendar between the States and Centre. Out this, more than 50 per cent is still left for the rest of the financial year. So, the supply calendar is huge, even after accounting for a very benign environment, including large liquidity surpluses and muted credit growth. That goes against a very sustainable fall in yields, till some new triggers emerge. Therefore, on the basis of the current supply dynamic, a sharp and sustainable fall in yields looks unlikely from here.
On the other hand, since the RBI has visibly shown its hand in stabilising bond yields with the recent set of measures, the market now has adequate comfort that the RBI will protect a certain upper side to this range as well. It seems the way RBI would look at the market today is that as long as yields are stable and within a range, and the government’s borrowing programme is going through, the central bank would consider it as a successful outcome.Where do you see opportunities on the long-end of the yield curve?
The yield curve is so steep that the spread between the one-year Treasury bill and seven-year government bond is roughly 250 basis points. This allows for a reasonable excess return over the one-year Treasury bill, if yields are in a range. Even accounting for minor mark-to-market fluctuations, it is a good carry-adjusted duration trade if one is positioned at the right points on the yield curve. Simply put, carry is income accrual from yields.
Gilt funds should not necessarily be looked at as buying into the longest duration asset available always. The yield curve is steep enough for portfolio strategies in gilt funds that position themselves at points on the curve, where carry versus duration risk trade-off seems optimal.
From investors’ point of view, they should keep a core and satellite allocation strategy. The core allocation should be to products that are conservative on credit risk and duration. The satellite allocation can be aggressive on duration or credit risk, or both. While gilt funds have no credit risk, there is significant amount of duration risk. Overall, not more than 20-30 per cent of investors’ fixed income allocation should go to satellite products. Within this, investors can add gilt funds.What kind of investment horizon do you suggest for investors?Investors should get into gilt funds with a horizon in excess of three years and not get attracted by the recent performance the category has delivered.