Where debt fund investors should park their money amid rate cut expectations

Mint spoke with debt fund managers about their outlook following RBI’s first rate cut in nearly five years and the fiscal policy measures announced in the Union Budget.

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Will yields fall?

Fund managers suggest that G-Sec yields could moderate with stronger liquidity measures from the RBI. Bond prices and yields are inversely related: a fall in yields generally leads to a rise in bond prices, and vice versa.

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“If inflation continues to ease as projected, demand from pension and insurance funds remains steady, and momentum builds, the yield could inch toward 6.5% over the next three to six months,” said Mahendra Jajoo, chief investment officer – fixed income at Mirae Asset Investment Managers. “For this to happen, the market needs greater confidence in the next rate cut and clarity on the RBI’s liquidity measures.”

Pankaj Pathak, fund manager-fixed income at Quantum AMC, notes that the market was disappointed by RBI’s monetary policy, as expectations were set too high from the start. He also points to a shift in the RBI’s policy tone that investors should not overlook.

On rate cuts

While investors can explore long-term opportunities in G-Sec funds, fund managers emphasize that rate cuts alone aren’t the only drivers.

“There could potentially be another two rate-cuts in 2025, but we are not seeing upside only from that,” said Marzban Irani, chief investment officer-debt, LIC Mutual Fund. 

“We expect demand for government bonds from insurance and pension funds to continue. Government is also continuing its work to control fiscal deficit, to bring it further down to 4.4%. India’s inclusion in Bloomberg’s emerging market debt index and potential improvement in global ratings, which is something the government is working, is also positive for yield over the long-term. All these steps will potentially have a cumulative positive effect on bond yields across the yield curve. So, long-term investors can also consider G-Sec funds,” Irani said.

Pathak adds that more liquidity measures are needed, and the RBI is already addressing the issue with an expansion in the size of recent Open Market Operations (OMOs). He expects three to four rate cuts from the RBI in 2025, to address sluggishness in growth, alongside further liquidity support. 

“These factors, along with favourable demand-supply dynamics, should drive down yields on ten-year G-Secs, benefiting long-duration funds like G-Sec funds,” he says.

Outside of G-Secs

Fund managers also see tactical opportunities in other categories of funds.

“PSU bonds are in a sweet spot in the 3-5-year segment. Banking & PSU Fund category is what we are recommending. Accruals in the category are around 7.30-7.40%. On post-tax basis, one can fetch 7.20% yield. The credit risk is low as these are AAA-rated PSUs and banks,” Irani explained.

“We are telling investors to stay put. than rate cut, as and when liquidity comes into the system yields should come down. That way investors will also get benefit of capital appreciation,” he added.

Jajoo is positive on corporate bonds. 

“Currently, the government bond yield curve is flat, while the corporate bond yield curve is inverted, with three-year yields exceeding those of five, seven, or even ten years. If the RBI cuts further rates and liquidity improves, the yield curve should regain its normal upward slope. Hence, there is an opportunity in the one-to-three-year corporate bond segment,” he said.

Jajoo says investors should maintain a diversified debt portfolio. “While there is a long-structural play on the G-secs beyond 2025, but investors should diversify their holdings within the debt basket. Keep in mind the long-term bonds, especially G-secs, tend to be more volatile than other segments of the debt market. In the current market environment, corporate bond funds also look attractive as the liquidity is starting to improve for the corporate bond market.”

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Pathak from Quantum AMC suggests that dynamic bond funds could be an alternative to long-duration funds. “Given the global uncertainty and the fact that some of market rally has already happened its better to be with dynamic bond funds, where the fund manager has the flexibility to move across the duration curve. Long duration funds do not have flexibility to respond to changes in the macro environment,” he said.