Mutual fund houses reiterate the appeal of 5-7 yr ‘sweet spot’

The yield on debt paper increases as its maturity goes upPremium
The yield on debt paper increases as its maturity goes up
 2 min read . Updated: 07 Apr 2021, 11:38 PM IST Neil Borate

In their reactions to the RBI’s monetary policy announced on Wednesday, mutual fund houses have reiterated their positive stance on debt funds investing in five-seven year bonds. Some launched a series of funds with this type of maturity last month. They have reiterated the attractiveness of this maturity.

The yield on debt paper increases as its maturity goes up. For example, if a one-year treasury bill fetches 4%, a five-year government bond might fetch 5.5%. This extra yield is offered to investors to compensate for the higher risk of holding long maturity paper.

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“The central bank has delivered on most of what bond market participants may have reasonably asked for, given the circumstances. The yield curve is very steep even at intermediate duration points (five-six years), thereby providing strong compensation for holding bonds as against cash," Suyash Choudhary, head of fixed income, IDFC Mutual Fund, said in a note to investors on Wednesday.

“Investors should expect low single-digit return from the bond market in FY22 and will have to increase their average maturity in order to optimize their risk-adjusted returns. We wish to highlight that investors at the short end (up to two years) will probably earn zero or negative real return (inflation-adjusted) in FY22, similar to FY21," said a note issued by Dhawal Dalal, CIO of fixed income at Edelweiss Mutual Fund.

“Prudent investors are requested to consider investing in high-quality bonds maturing in five years or higher via passively managed target maturity bond index funds as well as bond ETFs to benefit from diversification, transparency, simple and clear investment objectives and predictability of returns for hold-to-maturity investors in our opinion," he said.

Choudhary added: “The current yield curve is quite steep till five to seven years and then the additional duration risk taken may start overwhelming the additional carry-on offer. Hence, our preference in our active duration mandate remains best expre-ssed as an overweight in the five-six year part of the government bond curve; with the usual caveats on flexibility."

Amit Tripathi, CIO of fixed income at Nippon India MF, however took a more conservative stance on duration while taking a positive stance on credit. “Funds running constant duration strategies in the one-three year space and reducing duration strategies across the yield curve offer this good risk-return trade-off. As the economic and financial system normalization gathers pace, we also expect credit funds to regain ground driven by higher balance sheet visibility and comfort and reasonable spreads," he said.

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