Focus on the right time horizon for debt funds

A 220 basis point shift in the Reserve Bank of India’s (RBI) inflation projections over the past four months is perhaps the starkest example of the rapidly changing macroeconomic landscape we face. What began as a consensus view that inflation was transitory and driven by temporary supply-side disruptions has now evolved into an acceptance of the rigidity of these price pressures.

That said, there is good news on the horizon. Central banks including the RBI have embraced the new paradigm and have clearly shifted their focus from stimulating growth to limiting inflation. Governments have intervened with fiscal measures to combat supply-side price pressures. This may not resolve supply-side disruptions and supply-demand mismatches in the near term, but will impact additional demand and price pressures in the medium term as we let’s enter the restrictive monetary policy regime.

In the Indian context, the RBI and the markets are now nearly in sync in terms of inflation and growth projections for FY2023. The market, while itself having underestimated the magnitude of these pressure points earlier, has risen considerably since when inflation expectations shifted north by 6%. Multiple future rate hikes have been factored into bond yields, along with at least some of the additional pressure that may be building due to the supply and demand mismatch in the space. sovereign bonds. With the RBI now in sync, the expected rate hike path will be broadly in line with market expectations and what has been priced in. This means that the possibility of unpleasant surprises has been reduced.

Options for investors

Fixed income funds are a basket of products that offer various combinations of potential risk for investors and require relevant holding periods for returns to materialize. Even in the worst situations, there are products at the shorter end, such as liquid and ultra-short duration category funds, which offer a conservative option even for short periods, but with limited return potential. . But with the reduction in the magnitude of negative surprises, allocations in categories such as ultra-short/money market/low duration funds for a holding period of 3 to 12 months and short-term fund categories /banks and PSUs/corporate bonds from an 18 month duration + outlook are more acceptable from a risk-return point of view. The longer end of the yield curve, having also been significantly repriced, may still move for some time until investors are more comfortable with the supply and price dynamics. demand in G-sec markets. We are reaching levels where absolute returns can drive investment even in this space over the next 6 months. Similarly, target maturity ETFs/index funds have seen significant improvement in carry (portfolio returns) and continue to offer better return visibility, if held to maturity.

Over the horizon of the good holding period, nearly 90% of the returns on fixed income securities come from carry, which has evolved significantly over the past 12 months. While the noise around high inflation numbers and consecutive rate hikes will linger, what matters from an investor’s perspective are their holding period returns. While yields are not expected to start falling significantly anytime soon barring unforeseen macroeconomic events, what matters is the cushioning already available to manage such moves since the carry improved. The key in this environment is therefore not to minimize the risk, but to recognize the buffers already built to manage it.

Finally, the results of fixed income securities, with the exception of an element of credit risk, always depend more on the good holding period of the investments than on the short-term volatility of rates. This is especially the case in markets like today’s, which have tried to incorporate many negative elements. So focus on getting the right product base for your investment horizon and it should do reasonably well in the short to medium term.

Amit Tripathi is CIO of Fixed Income Investments, Nippon India MF.

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