Debt mutual funds have substantially trimmed their exposure to government securities since the RBI’s last rate cut in August 2017.
As of February 2018, open-ended debt funds held G-Secs worth ₹65,487 crore, down by a significant 39 per cent since July 2017. G-Secs constituted 5.9 per cent of debt MFs’ assets under management (AUM) as of February 2018, against 9.8 per cent in July last year, just before the RBI lowered its key policy rate by 25 basis points to 6 per cent. Interestingly, even as the RBI had then given in to market expectations and lowered its repo rate, bond yields have only been inching up since then.
The tightening of global liquidity and concerns over rising inflationary expectations and fiscal slippages on the domestic front have impacted the bond markets over the past few months. Debt fund managers, looking to tide over the volatility in the bond market, have pruned allocation in long-dated government securities and, instead, increased exposure to short-term debt instruments such as certificate of deposits (CD) and commercial papers (CP) between July 2017 and February 2018.
Open-ended debt mutual funds comprising gilt long-term, long-term income, dynamic income, short-term income, gilt short-term, credit opportunities, banking and PSU debt, ultra short-term and liquid funds, were considered for our analysis.
Gradual shift in allocation
In the past one year, debt fund managers have been cautious on interest rates movement.
One of the key factors that impacts bond prices is interest rate movements in the economy. If the interest rates move up, bond prices fall. This is because investors flock to newer bonds that offer higher rates. This reduces the attractiveness of older bonds and hence their prices decline. The reverse holds true under a falling rate scenario; bond prices move up. Thus rates and bond prices have an inverse relationship.
As longer-duration bonds are more sensitive to interest rates, debt funds that invest in long-term G-secs and corporate bonds tend to witness a drop in their NAV value when yields move upward.
Yields on 10-year government securities have hardened since August 2017 by 120 basis points to 7.6 per cent. Yields on 10-Year ‘AAA’ corporate bonds rose by 83 bps to 8.3 per cent during the same period.
“As the broad market interest rate trajectory has reversed over this period, there is a distinct shift in portfolio allocations towards lower duration assets,” says Rajeev Radhakrishnan, Head of Fixed Income, SBI Mutual Fund. Between July 2017 and February 2018, open-ended debt funds have decreased their exposure in G-secs and corporate debt, and in turn increased investment in short-term debt instruments –around 107 per cent in CDs and 16 per cent in CPs.
“The seasonal tightness in liquidity and changing expectations on the rate outlook have also provided higher relative yield opportunities in short-term bonds and commercial papers,” Radhakrishnan adds.
Dwijendra Srivastava, CIO-Fixed Income, Sundaram Mutual Fund, says, “Government securities have become volatile because of excess supply. The decline in corporate bond exposure is marginal because corporate bonds are less volatile than government bonds.”
Less volatility
Short-term income funds investing primarily in short-term instruments such as CDs, CPs, Repo and CBLO are less prone to volatility.
Since August 2017, better performing funds from gilt long-term and long-term income categories have delivered negative returns ranging between -1 per cent and -4 per cent while top funds from the short-term category registered positive returns of 2-5 per cent.