Fixed Income Funds Expect Cues From Bond Inflows, Policy Rates

Investors have flocked to equity mutual funds with Indian markets breaching new highs every other week, but they may have missed out on opportunities in the bond market. Having said that, fixed income fund managers believe that potential for capital gains still persist.

The inclusion of Indian government bonds in the JPMorgan index on Friday was a watershed moment for the country. But inflows into the bond market in anticipation of the event have already had a bearing on yields. Strong buying by foreign institutions pulled the yield on the 10-year benchmark government bond lower by around 40 basis points since October last year, with the yield on the paper now at around 7%.

Investors in long-duration bonds make capital gains when yields fall. That's because yield and price of bond are inversely proportional.

Some part of the impact of the inclusion is yet to pay out, according to Sandeep Yadav, head of fixed income at DSP Mutual Fund. Only about 30-35% of the inflows from the inclusion in JPMorgan's index have come so far, he said.

The proportion of inflow is greater than the outflow even in the case there is a dip in global investments. This is stickier money and it’s here to stay for a while, he said.

The Union Budget, expected to be presented this month, will provide the next major trigger for the bond market. In it, the government will lay out its priorities for the current financial year and will confirm its plan for market borrowing.

In the Interim Budget, presented in February, Finance Minister Nirmala Sitharaman had projected market borrowing of Rs 14.5 lakh crore for the current fiscal year. A significant deviation from this mark, either on the downside or the upside, would have a bearing on yields.

But, there is unlikely to be a major deviation from the plan, said Mahendra Jajoo, chief investment officer-fixed income at Mirae Asset Investment Managers (India) Pvt.

Instead, bond market participants are likely to focus on monetary policy action by the Reserve Bank of India. There could be a shallow rate cut by the RBI, said Jajoo.

Based on the factors currently at play, both Jajoo and Yadav anticipate that the yield on the 10-year government bond could fall further, possibly to 6.7%.

"I'm not saying that the RBI will cut rates in the next three years, but the next action is most likely going to be a cut and you will see a liquidity infusion," Yadav said. "I don't currently have a target in mind for yields, but I'll review my strategy when the 10-year yield falls to 6.7-6.8%."

DSP currently prefers investing in long-term bonds with maturities of 30 to 40 years, Yadav said. "Short-tenor bonds will rally when rate cuts happen and we don't have visibility on that right now," he said.

Jajoo echoes Yadav's view on long-duration bonds, but believes that the opportunity to buy bonds at the longer end of the yield curve have passed.

"We are not as heavily invested in the 30-40-year bonds, because the spreads there have collapsed," he said. However, his fundhouse is overweight on long-duration bonds because the only possibility on rate action from this point is a 'status quo' or a 'cut' in the interest rates.