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RBI rate cut: Banking and PSU debt funds still attractive, but return expectations tempered

Stick to funds with good track records and portfolios comprising bonds maturing within three years

March 27, 2020 / 08:00 PM IST

The markets have gone into a tailspin. Even debt markets have been hurt in recent times. Even liquid, and banking & PSU (BPSU) debt funds have witnessed a decline in their NAVs – the latter category by as much as 1.35 per cent in the last one week. Moneycontrol has been repeatedly suggesting making investments in BPSU funds over the past one year.

With the recent erosion in the value of these funds, should you worry about your investments?

Why did bond fund NAVs fall?

BPSU funds did not lose face an erosion in value because of any default. The sentiment ought to have improved in the bond markets after the moratorium on Yes Bank was lifted on March 18.

However, the bond markets saw a sell-off. Foreign investors sold bonds worth Rs 63791 crore in this calendar year, while purchasing only Rs 25882 crore of debt instruments. The market focused more on the outbreak of Covid-19 and its implications on the global economy.


“Due to the outbreak of Covid-19, investors are fearful as they cannot measure the impact on the economy. Hence there is rush to exchange bonds for cash,” says Deepak Panjwani, VP- debt markets, GEPL Capital. “There are not many buyers, and whoever is willing to buy is demanding a high yield (and so, low prices) even on good quality bonds. This panic selling has pushed up yields,” he adds. Many bonds of top-notch issuers were sold in desperation to raise cash. For example, the 7.61 per cent NHAI tax-free bond maturing in 2031 was quoting at a yield of 5.75 per cent on March 24 compared to 5.5 per cent at the beginning of the month.

“Yields on three months AAA-rated good-quality papers have hit 8 per cent levels, as there aren’t many buyers in the market. Based on liquidity requirements, trades are taking place even at high yields,” says Dwijendra Srivastava, chief investment officer-debt, Sundaram Mutual Fund.

Even investors with cash and willing to invest are treading with care. “Institutional investors are keen to invest in treasury bills over commercial papers, as the former come with sovereign guarantee and high liquidity compared to commercial papers. Though treasury bills are come with a tad lower returns, investors prefer safety and liquidity,” says Panjwani.

For liquid funds, the ‘financial year ending’ phenomenon played a key role. Each year, investments in liquid funds are sold by institutional investors to make tax payments before March 31. This reduces liquidity in the system and raises interest rates. Gold prices too tumbled, as investors were raising cash in these uncertain times.

Will the losses get reversed?

“As clarity emerges about the pandemic’s impact and investors’ anxiety recedes, there will be a shift from money market instruments to government securities and quality AAA-rated bonds,” Panjwani says.

There are couple of more factors that are expected to bring down the high yields.

Joydeep Sen, founder of foresees yields going down, as there is an expectation of an economic slowdown.

The RBI has announced measures to address the concerns of the financial system.

This should ease the liquidity freeze in the bond markets and bring down the yields. This should reverse the mark-to-market losses seen by the investors in the recent past.

RBI’s Monetary policy Committee has voted unanimously for maintaining an accommodative stance in the monetary policy.

Srivastava says, “If the interest rates in the economy were to go down, the top-notch (high credit-rated) securities should see lower yields as things settle down.”

What should you do?

Sen advises existing investors to stay put and not sell out after watching the mark-to-market losses.

BPSU funds, as a category, have done well for the investors in the past. However, investors should lower their return expectations.

Stick to funds with good track records and portfolios comprising bonds maturing within three years, especially if you are keen to reduce volatility. Low modified duration – a gauge of possible change in value of the bond in response to a change in interest rates – along with low credit risk, works better for investors with limited appetite for volatility.
Nikhil Walavalkar
first published: Mar 27, 2020 07:02 pm
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