Long-duration fund rally may halt as yields harden on rate-cut pause

In current calendar year, the foreign institutional investors (FIIs) have sold more than Rs 1 trillion worth of securities in the debt markets. Illustration: Ajay Mohanty
The sharp rally seen in long-duration funds on the back of softening bond yields and rate cuts may come to a halt, with the Reserve Bank of India (RBI) holding back from another rate cut and inflationary pressure rising.

Domestic yields on 10-year government securities (G-secs) have started to harden. On Tuesday, yields ended marginally higher at 5.95 per cent. Since the RBI’s no rate-cut stance on August 6, yields are up 14 basis points.

The consumer price index-linked (CPI) inflation for July was 6.9 per cent, against 6.23 per cent in the previous month.

Experts say it is not just inflation, but bond yields at the  long end of the yield curve could also be bottoming out.

“The capital appreciation opportunity from long-duration strategies may be limited. Yields may be bottoming out. Regardless of one or two more rate cuts, the yield movement is likely to remain range-bound,” said Vidya Bala, co-founder of PrimeInvestor.

Funds within debt categories, such as gilt funds and dynamic bond funds — which are oriented towards longer-dated G-secs — have delivered returns of 10-15 per cent in a one-year period.


“Yields may not come down at the same pace, but still there is no case for a substantial increase in yields,” said Mahendra Jajoo, chief investment officer-fixed income at Mirae AMC.

Experts say debt funds at the shorter end of the curve will still have a good carry and could hold on to their return profile. Debt mutual fund investors had been warming up to gilt funds and dynamic bond funds because of robust trailing returns and lack of credit risk, with portfolios being oriented towards G-secs.

In July, gilt funds garnered Rs 3,395 crore of net flows, while dynamic bond funds garnered Rs 2,019 crore of net flows.

Fund managers don’t rule out the possibility of RBI intervention, which can keep bond yields in check. “For yields, what matters is the RBI’s support for the (government’s) borrowing programme, which, so far, has been relatively ‘light touch’, and not so much the prospects for further rate cuts,” said Suyash Choudhary, head-fixed income at IDFC AMC. 

Experts say the demand-supply scenario in the debt market will also have a bearing on yields. “The government borrowing is likely to remain elevated. This will entail a higher supply of G-sec papers in the debt markets. However, demand is likely to remain weak,” said a fund manager.

In the current calendar year, foreign institutional investors (FIIs) have sold more than Rs 1 trillion worth of securities in the debt markets.

“External factors, such as currency movement and capital market flows, can also have an impact on the yield movement,” Bala added.  

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