Everyone in the bond market is showing some interest in long-term bonds, while a few may be more interested than the rest. Mutual fund houses such as Axis Mutual Fund and SBI Mutual Fund have announced the launch of long-duration funds. Should you invest?
What is on offer?
Long-duration funds construct bond portfolios with a duration in excess of seven years. This is achieved by investing in very long-term bonds. The Axis Long Duration (ALD) Fund will be managed by Devang Shah, Kaustubh Sule, and Hardik Shah, and the SBI Long Duration (SLD) Fund by Rajeev Radhakrishnan. ALD will track Nifty Long Duration Debt Index A-III, and SLD is benchmarked against CRISIL Long Duration Fund AIII Index.
What works?
These schemes generally invest in good quality bonds, and both SBI and Axis are no different. Both schemes will be investing in long-term government securities (G-Secs). These schemes will buy and hold on to the bonds they invest in. In mutual fund (MF) parlance, this is known as roll-down strategy. The idea is to keep earning interest without taking much credit risk. For investors looking at long-term investments in bonds, this can be an attractive investment option. The fund house collects the coupon and keep investing it in bonds of similar maturities.
After a cumulative increase of 225 basis points (bps) in the repo rate by the Reserve Bank of India (RBI) since May 2022, most market participants see the interest rate hike cycle to be more or less behind us. The current yields on long-term bonds are attractive, and it would be a good idea to lock in at the prevailing level.
Devang Shah, Co-Head, of Fixed Income, Axis AMC, says, “Coincidently, we have already seen a large quantum of rate hikes in a short span of time, which makes the entry point attractive. However, this product is not for those who are keen to take a tactical call on interest rates. Instead, investors could look to invest with minimum a timeframe of 10 years to fund long-term financial goals.”
For debt fund investments held for more than three years, capital gains booked are taxed at 20 percent with indexation. That makes this an attractive investment for investors in the high-income tax bracket keen to avoid credit risk and invest for the long term.
“The prevailing yields offered by long-duration instruments are attractive. Long-term debt investors and debt allocators can view the products to lock-in investments at decent yields along with favourable taxation and indexation benefits compared to conventional fixed-income alternatives,” says Nirav Karkera, Head-Research, Fisdom.
What does not work?
Investments in long-duration funds face high-interest rate risk compared to those in short-duration funds. When interest rates go up, bond prices fall, and vice versa.
Some investors may want to look at these schemes as a means of making a quick buck when interest rates are on their way down. Currently, many investors are of the view that interest rates are nearing their peak and may soon head downwards. However, RBI may take longer than expected to cut interest rates.
“With the central bank gaining a stronger handle on inflation beyond the 6 percent threshold, we can expect the interest rate policy to plateau and remain so for a long. While higher rates could challenge economic growth to some degree, it is far from being a deterrent under the current circumstances,” says Karkera.
Though some savvy investors may use such long-duration products with a focus on good quality bonds as a supplement to their fixed-income investments through a voluntary provident fund (VPF) and public provident fund (PPF), the pressure exerted by interest rate movements can be unnerving and investors need to be prepared to hold on to their investments during rising interest rate cycles.
“As such products are generally used for fund-long term financial goals, the investor should come in with a long-term horizon and not try to time the market. There will be interest rate cycles in the market. And in bear phases, returns from such products will be muted, which is why these funds require a long-term horizon,” says Joydeep Sen, Corporate Trainer-Debt.
Investments with a short-term horizon in such products in a rising interest environment can inflict losses on the investor.
“Regular investments made with a long-term view in this scheme may help investors ride out movements in interest rates and resultant volatility,” says Shah.
What should you do?
Investments in such funds can be rewarding if one has a view of more than a decade to build a large enough corpus without taking much risk. There are already two schemes, Nippon India Nivesh Lakshya Fund and ICICI Prudential Long Term Bond Fund, in this segment.
Ideally, investors should be willing to invest in such schemes at regular intervals. It helps to average out the purchase price of the units. Investors should consider schemes such as ALD and SLD after taking a look at their respective portfolios and expense ratios.
The new fund offering (NFO) of ALD will close on 21 December, and that of SLD, on 20 December.