2022 could turn out to be the year of the debt fund by Mr Nityanand Prabhu Executive Director and Business Leader, LIC Mutual Fund Asset Management Ltd


As RBI shifts into rate hike mode, bond yields suddenly surged. India’s 10-year G-sec yield has rallied since the outbreak of the pandemic, rising from 6% in July 2020 to 7.6% on June 13, 2022 (Source: Bloomberg). This indicates that as the year progresses, as bond yields enter their attractive range, debt funds are attracting investors’ attention. If this continues, 2022 could become the year of debt funds.

Financial markets have gone through a series of hurdles and a meaningful recovery may not be imminent. Nevertheless, in the longer term, the equity market may continue to attract retail holdings through the SIP. Historically, equities have emerged as one (if not the only) asset class to consistently generate positive returns relative to inflation. Stock markets could take a few more quarters to rebound. The debt market, on the other hand, has been attracting attention lately, with central banks around the world tightening the liquidity rope.

What can investors do?

Our analysis has led us to believe that now may be a good time to invest in long duration funds. Investing in such a fund can not only help you lock in your funds at reasonably attractive levels, but can also provide you with the opportunity to take advantage of a rally in the bond market, should yields correct from here. In 2021, LICMF has been proactive in identifying rate hikes well in advance and we have reduced the duration of our long duration funds to a minimum, protecting investors’ wealth in a rate hike scenario. interest. We have now started increasing our durations to take advantage of potential yield corrections. We expect a further 75 basis point rate hike by December 2022. However, we also believe the same may have been factored into the current pricing of bond yields, making current levels an attractive level to invest in. .

If experts are to be believed, current bond yields may have priced in a large portion of expected future rate hikes. In order to understand this in depth, we performed an analysis by looking at historical data. The analysis revealed that interest rates are a lag indicator while bond yields are a leading indicator.

Repo rate vs 10yr G-sec

May 22, 2020 June 16, 2022 Increase
Pension rate 4.00% 4.90% 90bps
10 years G-Sec Yield 5.75% 7.60% 185 basis points

Bond returns are by nature forward-looking. As shown in the chart above, the 10-year G Sec peaked in mid-July 2008 before repo rates peaked in August 2008. Thereafter, yields began to correct in September 2008 long before repo rates fell. This phenomenon is observed in almost all periods of tariff action. This could also be the case today where repo rates rose 90 basis points while bond yields rose disproportionately 175 basis points.

G-Sec Spread over Repo – A Crucial Indicator

Interestingly, the spread between the Repo rate and the interest rate can give us a directional indication. We did another analysis to look at the spread between the G-Sec yield and the Repo rate.

G-Sec Spread over Repo - A Crucial Indicator
G-Sec Spread over Repo – A Crucial Indicator

We see that sooner or later, the spread corrects and approaches its average of 1.2%. Currently, the spread at 3.12% is close to its all-time high of 3.22% recorded during the GFC (Global Financial Crisis). Thus, it can be interpreted that we may have entered the lower end of the upward sloping yield curve and the yield correction may be imminent. Investors can watch the levels closely.

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