Over the year, central banks around the world ended the decade-plus period of easy money by withdrawing or steeply shrinking their bond buying exercises. Rates were hiked by a massive 3-4 percentage points.

Yields harden at the short end

In India, though the yields in the bond market were hardening even early in the year, and inflation was on a steep upward trajectory, the RBI increased rates only from May. Since then, however, it has made up for lost time by hiking the repo rate by as much as 225 points.

-         The 10-year g-sec yield moved just about 85-90 basis points in the last one year. In fact, since April (RBI first hiked rates in May 2022), the movement has just been 20 basis points to 7.3 per cent currently. In contrast, the shorter end of the curve overnight, call market and ultra-short duration bond yields are up 200-300 basis points in the last one year. The term premium for 5-plus years tenor bonds was low or non-existent.

-         As the year progressed, the stiff rate hikes brought about fears of a global slowdown and even a recession. Commodities – mainly crude and metals – corrected steeply from their highs. The CPI finally fell for two successive months recently and WPI has come down to single digits. With normal to bumper crop season expected, food inflation is expected to move with a downward trajectory.

-         Revenue buoyancy with both direct and indirect tax collections being robust and expected to exceed budgetary estimates, the government’s strict fiscal path, no undue pressure on the currency and FPIs turning net buyers over the past couple of months are all positives.

-         The banking sector’s liquidity as measured by per cent of NDTL (net demand and time liabilities) has been positive all through the rate hike period. Indeed, it has been positive for three years now, and has kept yield movements in a narrow band.

Thus, the RBI would either pause or hike rates by just 25 basis points and we should have a terminal repo at 6.5 per cent.

Investing in bonds amidst high interest rates

So, where should fixed-income investors park their money in 2023? Much will depend on your goal horizon and asset allocation. Investments via lump-sums are needed for generating the same yields.

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Fixed deposits: For ultra-conservative investors, the good old fixed deposit may still be a good choice. Credit growth in the financial system is northwards of 16-17 per cent in November-December, while deposit growth is just around 10 per cent. Therefore, lenders will have to raise deposit rates further. Lock into quality small finance and regular bank deposits, or those from AAA-rated NBFCs (HDFC, Bajaj Finance) as they nudge 8 per cent rates.

Money manager funds: These are for low-risk investors and for those looking to park their emergency funds or goals that are just a year or so away. The yields to maturity have gone up steeply – 200-300 basis points – in the last one year for these funds and are nudging 7 per cent or more. Aditya Birla Sun Life Money Manager and SBI Savings would be good choices as, on a 3-year rolling basis over the last 10 years, these funds have managed 7.5 per cent returns.

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Floating rate funds: These are suitable for moderate to high-risk investors looking at bond investments for the medium term of 3-4 years, which is the average maturity period in most floating rate funds. This portion of the yield curve has witnessed limited action. In the current environment, floating rate bonds can give a kicker to your debt portfolio’s returns, given that coupons are reset periodically. GoI FRB yields are a good 25-67 basis points higher than equivalent fixed rate coupon bonds. Many schemes in this category have given in excess of 8 per cent returns on a rolling 3-year basis over the past 10 years. Aditya Birla SL Floating Rate, Nippon India Floating Rate and HDFC Floating Rate Debt are good choices.

Target maturity funds: These funds are the best for investors not wishing to deal with interest rate and duration risks. Bharat Bond ETFs and debt index (developed by CRISIL and NSE) funds are available for tenors ranging from four to 15 years. Yields of 7.4-7.66 per cent are attractive. You can also follow a laddering strategy by investing in funds maturing in successive years to coincide with your goals.