Long Duration Fixed Income Mutual Funds Remain Attractive Ahead Of Likely Rate Hike

Fixed income mutual funds of longer duration continue to gain attractiveness amidst impending monetary easing, along with the economy's resilient macro-economic fundamentals.

The duration of funds investors are opting for, is rising with expectations of rate softening likely to continue to give higher returns, Vikram Pamnani, Senior Fund Manager at Baroda BNP Paribas Mutual Fund said. Long term gilt funds and corporate funds with a tenor of 3-4 years both appear good options, given the macro fundamentals and given that demand is expected to continue to exceed supply, he explained.

The US has started cutting rates and is likely to cut rates further, said Deepak Agrawal, Chief Investment Officer- Fixed Income and Head at Kotak Mahindra Mutual Fund.

Closer home, while retail inflation has seen a bump-up, it is expected to ease in the coming months. Along with the rate cuts, the demand and supply too appear to favour bond yields, with low government expenditure likely to result in chances of government borrowings coming in lower than estimates. That, along with the index inclusion also means that yields on the benchmark could touch 6.5% in the course of the next one year or so, Agarwal explained.

Along with demand expected to outstrip supply, the RBI's guidelines on Liquidity Coverage Ratio too are expected to be a positive for gilt and corporate bonds, said Sandeep Yadav, Head of Fixed Income at DSP Mutual Fund. An impending rate cut is expected to be a positive for FII inflows, he said, suggesting picking the longest duration in both baskets. On gilt funds, returns have been trending at about 9.5-10% though this year could see modestly lower returns, Agrawal said. Still, there is merit in increasing the duration of funds as per the risk appetite. Investing in longer duration funds would mean lower risk of reinvestment, he explained. However, while interest rates are likely to trend downwards, longer duration does mean higher volatility, he cautioned.

Within the fixed income basket, people who can time the market should invest in long duration funds, but these can also be very volatile and risky such as in scenarios where the yields could rise going ahead instead of the expected decline, explained Dwijendra Srivastava, Chief Investment Officer- Debt at Sundaram Mutual Fund. "Its a tactical play if rates go further down," he said.

Along with long duration funds, mid duration funds also are seeing good returns, he said, suggesting dynamic bond funds, corporate bond funds and banking PSU funds.

Still, it's important to remember that most of the market comprises of shorter tenor funds. While about 5% of the investments are in overnight bills, up to 60-65% are in bills of up to one year, with about just a tenth of all investments in very long tenors, he added.

Post the changes in taxes levied on debt mutual funds in 2023, this category has lost sheen. Amendment to Finance Bill 2023 scrapped the indexation benefit on debt mutual funds, with the category now taxed at applicable slab rates.