Foreigners Back India Bonds Over Pricey Stocks In Tactical Bet

(Bloomberg) --

Overseas investors are pouring more money into India’s sovereign bonds than stocks, drawn by their relatively lower valuations and upcoming inclusion into global debt indexes.

Global funds have plowed a net $4.1 billion into the nation’s debt since Jan. 1, with government securities luring the bulk of the flows ahead of their addition to JPMorgan Chase & Co.’s emerging market index from June. In contrast, they’ve pulled $3.9 billion from local shares during the same period.

At the heart of the matter is India’s equity valuations which are among the most expensive in the world after eight years of annual gains in local shares. For bulls who powered the massive rally, the tactical trade at the moment is to move into the bonds, whose appeal has been further burnished by the nation’s improving finances and burgeoning foreign reserves. 

“Bond yields offer reasonable compensation over inflation and have the potential to participate in interest rate cuts,” said Gautam Samarth, a multi-asset fund manager at M&G Investment Management. He said there’s a case from a “tactical perspective” for bonds over stocks given the equity market’s rich valuations.

India’s bonds have risen over the past three months on the prospect of global index inclusion, and they extended gains in February after the government’s interim budget surprised with a smaller-than-expected borrowing plan for the financial year starting April.  

The nation’s index-eligible bonds, known as Fully Accessible Route or FAR bonds, have drawn about $8 billion of investments since the September announcement of index inclusion, with the pace of inflows accelerating this year. 

The yield on the benchmark 10-year note has declined almost 30 basis points from an October high to 7.08% on Friday. That’s much higher than the 4.4% earnings yield for the popular S&P BSE Sensex Index. The main equities gauge trades at more than 20 times future earnings, higher than its 10-year mean.

The outlook remains bright, given expectations of declining yields both in the US and at home, according to Manish Jain, head of equities and bonds at Mirae Asset Capital Markets. Indian bonds may yield about 9% over the next year, compared to the potential for a further 7-8% upside in equities, he said. 

Along with the outlook on bonds, equities could also perform well, given the strong growth picture in India, said Rajeev De Mello, a global macro portfolio manager at Gama Asset Management SA. “Bond markets have rallied already, but they can do far more once the global rate-cutting cycle begins,” he said.

(Updates with foreign inflows in the second paragraph. Yields in seventh)

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