Mixed signals from bond fund managers; what should mutual fund investors do
Mutual fund managers seem to have starkly divergent views on the outlook for the bond market. The disparate positioning of various dynamic bond funds, which are considered a proxy for the fund house’s fixed income stance, indicates that fund managers are not aligned on interest rates. The positioning of dynamic bond funds is best explained by the portfolio duration or average maturity. Both reflect the sensitivity of the portfolio to interest rate changes. Bond prices and interest rates are inversely related.Longer tenure bonds are particularly sensitive to interest rate changes. When fund managers expect rates to fall, they increase the portfolio duration or average maturity by switching to longer tenure bonds. This allows the fund to fully capture capital appreciation in underlying bonds. When interest rates are likely to climb, fund managers typically reduce the duration or average maturity by moving to shorter duration bonds. This protects against erosion in value from marked-to-market hit on underlying bond prices. We looked at what dynamic bond funds are actually hinting at.
The maturity profiles of dynamic bonds paint a contrasting picture. Mirae Asset Dynamic Bond Fund and UTI Dynamic Bond Fund are running an The contrasting positioning of various dynamic bond funds indicates that the fund managers are not aligned on interest rates. Mixed signals from bond fund managers average portfolio maturity of 3.3 years and 4.51 years, respectively. PGIM India Dynamic Bond Fund and ICICI Prudential All Seasons Bond Fund have also opted for a conservative stance with a preference for shorter tenure bonds. Meanwhile, DSP Strategic Bond Fund and Bandhan Dynamic Bond Fund are sitting at the other end of the yield curve, running an average portfolio maturity of 18.98 years and 11.35 years, respectively.
This aggressive positioning suggests that the funds are targeting capital appreciation from longer tenure bonds in anticipation of lower interest rates. The other funds’ positioning is scattered within this broad range. A couple of funds are following a roll-down strategy, by investing in bonds maturing near a target date and holding till maturity. The divergence in funds’ positioning comes at a time when there is broad consensus that interest rates are near the terminal rate in the current cycle. Central banks across the world have opted for a breather in the rate hike cycle.
Domestically, the RBI, in its last policy review, kept the repo rate unchanged at 6.5% and maintained its fiscal 2024 inflation forecast at 5.4%. The 10-year benchmark yield shot up to nearly 7.4% after the RBI hinted at bond sales. Meanwhile, the US Federal Reserve is expected to keep policy rates higher for longer, with rate cuts not anticipated until later next year. While some fund managers are optimistic that yields will start softening sooner, others are watchful of sticky inflation, higher oil prices and steep US bond yields. Suyash Choudhary, Head, Fixed Income, Bandhan MF, shifted his overweight stance to 9-14 year government bonds, from the 5-6 year space in active duration bond and gilt funds after the news broke about India’s inclusion in JP Morgan’s Emerging Market Global Bond Index.
Dynamic bond funds: Disparate stance
While some funds are primed for softer yields, others are awaiting clarity on inflation and external risks.
Firm that policy rates have peaked in India, he finds the risk-reward profile more favourable in this segment. Likewise, Sandeep Yadav, Head, Fixed Income, DSP Mutual Fund reckons that market dynamics in India point to lower yields, contrary to global yield rise. “We prefer to invest in our expectation of unbalanced reward of the Indian bond market, rather than the noise created by local issues in other countries. Sooner or later, yields have to reflect the Indian economy. Hence we are invested in higher duration,” he says.
Puneet Pal, Head, Fixed Income of PGIM India MF, expects that the RBI, akin to global central banks, will be on a long pause. The rate cutting cycle in India will start only when the developed market central banks have addressed the challenge of inflation effectively. “Investors with medium- to long-term investment horizons can look at funds having duration of three-four years with predominant sovereign holdings as they offer a better risk-reward profile currently,” asserts Pal. Nikhil Kabra, Fund Manager, Fixed Income, ICICI Prudential MF also feels rate cuts are far away. “We are in a state of interest rate neutrality. Unless there is a slowdown in economic growth and inflation fails to cool off materially, the RBI is unlikely to cut interest rates. Duration is not very attractive as the yield curve is flat with close to no term premium built in currently,” he says.
The investors seeking a play on interest rates also face a dilemma. Kirtan Shah, Founder of Credence Wealth Advisors, feels the positioning of dynamic bond funds may not necessarily represent the fund house’s actual stance. “Dynamic bond funds are perceived to be very nimble in their positioning, but it is not as straightforward.” He explains that dynamic bond funds’ agility is often constrained by the liquidity in underlying bonds. High exposure to corporate bonds may stymie the ability to easily switch between long-term and short-term bonds in alignment with the fund manager’s stance. This manoeuverability gets tricky without persistent inflows. “Not all dynamic funds are true to label,” concurs Rushabh Desai, Founder, Rupee with Rushabh Investment Services. He reckons that fund managers may wait for further RBI commentary before taking a decisive call. Some might choose to alter positioning closer to the start of the actual rate cut cycle. Till that time, investors would possibly do well not to go all in and remain mid-segment (four-seven years) on the yield curve.
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This story originally appeared on: India Times - Author:Faqs of Insurances
