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No big bang RBI policy! Expect low, single-digit returns from bond market in FY22

If growth recovery gets back on track as Covid-19 infections decline, focus may shift to policy normalisation. Fund managers say RBI has already exhausted monetary policy options to support growth and any further reduction in policy rates is unlikely

RBI Governor Shaktikanta Das RBI Governor Shaktikanta Das

The second bi-monthly monetary policy for fiscal 2022, expectedly retained a status quo on key policy rates. This is the sixth consecutive time rates have remained unchanged. This time too, the repo rate has been kept at 4 per cent. The reverse repo rate or the central bank's borrowing has been unchanged at 3.35 per cent. Apart from its focus on revival and sustaining growth amid the second wave of covid, the RBI is concerned about the upside risk to inflation and stability in the bond market.

The Reserve Bank has announced G-SAP 2.0 for Q2FY22 under which the RBI will purchase bonds worth Rs 1.2 lakh crore from the open market. Bond market experts expect bond markets to take comfort from continued the RBI's support.

"There is no doubt in our mind that the RBI wishes to see bond yields trending down. The RBI Governor's comments during the speech that "We do expect the market to respond appropriately to this announcement of G-SAP 2.0" highlights that point, in our opinion. We believe the RBI will continue its efforts of some sort of yield curve control until there are clear signs of revival of economic growth while seeing through recent increase in supply-side inflationary pressures," says Dhawal Dalal, CIO-Fixed Income, Edelweiss AMC.

The RBI is supposed to conduct the third and final tranche of bond purchases worth Rs 40,000 crore under G-SAP 1.0 on June 17, 2021, of which, Rs 10,000 crore will be for SDLs.

Also read: RBI MPC meet: GDP growth expected to be 9.5% in FY22

Apart from G-SAP 1.0 and prospective G-SAP 2.0, the RBI has also purchased IGBs worth Rs 36,500 crore from the open market so far. This has contributed to the reduction in volatility in the bond market.

Gilt yields are stable post policy announcement with the current 10-year benchmark gilt trading around 6 per cent. "Given the RBI's active and dynamic management of primary auctions, and OMOs (Open Market Operations), any rise in gilt yields on inflationary and fiscal concerns may be tempered by the RBI's actions," says Bekxy Kuriakose, Head - Fixed Income, Principal Asset Management. In the near term, she says, she expects money market yields to remain stable.

In light of the above, Churchil Bhatt, EVP & Debt Fund Manager, Kotak Mahindra Life Insurance Company sees 10-year Benchmark Gsec to continue to trade in 5.90 per cent -6.10 per cent range in the near term.

Also read: Central bank maintains status quo; trims FY22 GDP forecast to 9.5%

Interest rate reversal?

If growth recovery gets back on track with the lowering of new Covid-19 infections, the focus may shift to policy normalisation. Fund managers believe the RBI has already exhausted the monetary policy options to support growth and any further reduction in policy rates is unlikely.

As per Pankaj Pathak, Fund Manager-Fixed Income Quantum Mutual Fund, the next move in policy rates will be an increase, though it may not happen in the current calendar year. "We expect bond yields to move higher gradually over the medium-term. The RBI may start with hiking the reverse repo rate first by early next year followed by a calibrated increase in repo rate," said Pathak.

Where should debt MF investors put in money?

Investors should follow a balanced asset allocation approach for investing in debt funds and look at high-quality short-term debt categories for core allocations. "Given the expectation of rising interest rates, it would be prudent for investors to focus on shorter-maturity funds which impact less when yields rise," says Pankaj Pathak.

Bond prices and debt funds' NAV fall when the market yields move up.

Conservative investors, Pankaj Pathak adds, should stick to very short maturity debt categories like liquid funds. Investors with longer holding periods and with an appetite to tolerate intermittent volatility could consider dynamic bond funds, which can change the portfolio's risk profile, depending on evolving market situations.

Axis Mutual Fund sees an opportunity to invest in credit space for investors with three to five years of the investment horizon. They believe, "An improving economic cycle and liquidity support assuage credit risk concerns, especially in higher-quality names. While we remain selective in our selection and rigorous in our due diligence, we believe the current environment is conducive to credit exposure."

Returns you should expect from debt MFs?

Fund managers suggest investors lower their return expectation from debt funds as the potential for capital gains will be limited going forward. "Bond investors should expect low, single-digit returns from the bond market in FY22," says Dhawal Dalal.

He explains four distinct buckets of returns for investors to choose from:

  • 3 per cent bucket: Risk-averse investors focusing on up to 6M average maturity of assets may earn ~3 per cent returns in FY22.
  • 4 per cent bucket: Bond investors focusing on 6M to 1Y maturity bucket may earn ~4 per cent returns in FY22.
  • 5 per cent bucket: Bond investors seeking ~5 per cent returns in FY22 should focus on high-quality bonds with residual maturity of 1 to 3 years.
  • 6 per cent bucket: Bond investors seeking ~6 per cent returns in FY22 will need to increase the average maturity of their fixed income portfolios to 5 to 10 years.

Also read: RBI lowers real GDP to 9.5%, closer to Moody's estimate of 9.3%