Your debt mutual fund investments after RBI policy: Three top fund managers advise what to do

RBI Governor Shaktikanta Das presented the monetary policy statement. (Image credit: ANI/Twitter)

The Reserve Bank of India (RBI) surprised everyone in its monetary policy announcement on Thursday. It kept interest rates steady and belied market expectations of a small reversal in the reverse repo rate. As opposed to the global trend of central banks sucking out liquidity from the system and also hiking—or at least strongly signalling a hike—in interest rates, the RBI maintained status quo ante.

Bond market experts here too, had predicted a hike in interest rates beginning 2022. For starters, many debt fund managers and debt market experts had predicted a reversal in the reverse repo rate (the rate at which the RBI borrows from banks) to begin with in Thursday’s monetary policy. Following that, a change of the RBI’s stance (from ‘accommodative’ to ‘neutral’) and then eventually a hike in repo rates (the rate at which banks borrow from the RBI). That chain didn’t start on Thursday.

Debt fund managers, too, have been bracing themselves for a hike in interest rates. When interest rates go up, the prices of bonds and debt securities fall. The net asset values of debt funds that invest in them fall too. Many debt funds have reduced the average maturities of their portfolios over 2021. The higher the scheme’s duration, the more sensitive it is to a change in interest rate. Government securities (G-sec) funds have brought down their maturities to a little over six years, down from eight years in August 2021. Other categories like medium- to long-duration funds and low-duration funds have also reduced their maturities, on average, as per figures by ACE MF.

Despite the RBI keeping the interest rates steady for now, the broad consensus is that this won’t continue for long. That has a bearing on your debt fund investments. Moneycontrol spoke to three leading debt fund managers to give you their perspective of how investors should plan debt investments in 2022.

In the just-concluded monetary policy committee (MPC) meeting, all rates have been kept unchanged. There were market expectations that the reverse repo will be restored gradually. However, the MPC members voted to continue its ‘accommodative’ stance as long as necessary to revive and sustain growth, while ensuring that inflation remains within the target range. Jayant Verma was the only member on the committee who expressed reservations.

Going ahead, as far as retail investors are concerned, they should remain cautious due to huge borrowing starting April 2022, global bond yields inching upwards and elevated commodity prices. They should stay invested in schemes that have maturities of—and are meant for—a time horizon of one to three years, depending on their risk appetite, like low-duration bond funds and short-term debt funds.

Another announcement was on the voluntary retention route limit for foreign portfolio investors (FPIs) which was almost used up. Increasing the limit here helps to bring in additional investment. Additional buying in the market will help bond yields anchor to some extent as the supply from April is huge which domestic investors might find it difficult to absorb. Also, with no government securities acquisition programme this year, RBI intervention will be limited.

The Reserve Bank of India (RBI) surprised the markets by not only maintaining status quo on rates but by also giving an extremely dovish guidance for the year ahead. Bond market rejoiced and long-term bond yields are heading back towards pre-budget levels.

Thursday’s outcome is even better for the short to medium term segments as they were more susceptible to any indication of change by the RBI in managing liquidity and guidance on interest rate hikes.

Given that the rate hikes seem delayed, returns from money market funds will remain benign.

For the medium to longer end of the bond markets, it is back to watching oil prices, US treasuries and the weekly demand/supply situation in the auctions.

We continue to maintain that the RBI will move its policy stance to ’neutral’. At present, it is ‘accommodative’. It will move the operational policy rate to the repo rate. And it will hike the repo rate by 100 basis points (bps) by March 2023.

Liquid funds thus remain a good way to play this coming interest rate tightening cycle as an alternative to bank savings and short-term fixed deposits.

Given the steepness of the yield curve, there are opportunities at some segments of the government bond yield curve. If you have a time horizon of more than three years, a combination of liquid fund and, say, a dynamic bond may work well over locking in at current rates in fixed deposits, provided you gradually increase your allocation to dynamic/long-term bond funds on every rise in market yields in the coming year.

Budget day bond yields reacted in furore (more than expected gross borrowing)

Monetary policy day we saw bond prices soar (status quo on rates)

Someday there is fear, another day there is fear

What then should be the way forward for the investor dear?

The key is to stick to asset allocation far or near

Greed and fear cannot be emotions that make your portfolio steer

Try to match your intended investment horizon with the portfolio duration

Helps ride through volatility and reduce unwanted palpitation

Rates will eventually rise, will show in the bond price

Focus on portfolio carry, makes you feel less weary