Home >Money >Personal Finance >Debt MF investors may get tactical opportunity in yields, indexation

A surge in bond yields in India over the past few months has brought them close to the levels of April-May last year.

That was the time when the first covid-19 wave hit India and the nation went into a lockdown. A heavy dose of monetary stimulus by the Reserve Bank of India (RBI) had brought down yields and supported the debt market in the following months.

According to some fund managers, the current surge in bond yields is also a tactical opportunity for investors. If you invest before 31 March 2021, you could also get an additional year of indexation, they argue.

Bond yields have risen in 2021 after dropping steeply in April-July 2020 and staying low for the rest of the calendar year 2020
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Bond yields have risen in 2021 after dropping steeply in April-July 2020 and staying low for the rest of the calendar year 2020

Rising bond yields are associated with falling bond prices. Debt mutual funds have taken a beating with the recent surge in yields. The three-month average return of corporate bond funds is -0.31% while the three-month return of banking and PSU debt funds is -0.40%. The pain is most acute in dynamic bond funds and long duration funds with returns of -0.80% and -1.71% over the past three months, according to data from Value Research as of 19 March 2021.

“We believe that the recent increase in yields is mostly driven by weak sentiments in the bond market and higher US Treasury yields, and are not due to any adverse change in the macroeconomic landscape or any change in demand-side factors. The recent increase in bond yields should be taken advantage of, rather than waiting for further increase in yields in FY22 or beyond," said a research note issued by Dhawal Dalal, chief investment officer, fixed income, Edelweiss Mutual Fund.

Fund houses have launched a spate of roll-down target maturity funds this month, encouraging investors to lock in yields.

These launches particularly targeted the 5-7 year bucket. which they saw as a sweet spot in the yield curve.

These include the Edelweiss Nifty PSU Bond Plus SDL Index Fund-2026, IDFC Gilt-2027 and -2028 Index Funds and Nippon India ETF-5 year Gilt.

Mint had earlier written about this in detail (

“We don’t give tactical calls. But medium duration debt (5- to 7-year paper) is well positioned, given the yield curve. Even if there is a 100-150 basis points increase in yields in the next three years, you will be better off in paper of this maturity than holding say 2- to 3-year paper. The yield differential will make up for this kind of a rise in interest rates," said Anurag Mittal, fund manager, IDFC Asset Management Company. One basis point is one-hundredth of a percentage point.

Fund houses have also emphasized on the benefit of investing in debt before 31 March in order to take advantage of indexation for an additional year. Indexation is the benefit provided on long-term capital gains in various assets, including debt mutual funds. It allows investors to increase their ‘cost of acquisition’, while calculating capital gains and, thus, reduces taxable capital gains.

Indexation is calculated every year. Investing towards the end of the financial year can get you indexation for that year, on par with someone who has invested at the start.

For example, if you invest on 30 March 2021 and redeem on 5 April 2024, you will get the indexation benefit for four years (FY21, FY22, FY23 and FY24), even though you have held the investment for only slightly more than three years.

Aditya Birla Sun Life Mutual Fund, in a notice on 22 March, asked investors in six of its fixed maturity plans (FMPs) to extend their maturity to 2022 and 2023.

In its notice, the fund house strongly advanced the case for availing the benefit of additional indexation. “Owing to low yields on offer to investors, it will be prudent for existing investors to make maximum use of indexation benefit and opt for extending the investments," it said.

On the flip side, some key risks await mutual funds entering debt at this point.

A recent Securities and Exchange Board of India (Sebi) circular to treat additional tier-1, or AT1, bonds as having 100-year maturity rather than the existing practice of valuing them till their call dates, has sent the mutual funds industry into a tizzy. Debt fund managers have expressed apprehensions about writing down values of their holdings due to the revaluation. Following an office memorandum from the department of financial services of the ministry of finance asking for this provision to be withdrawn, the regulator introduced a new circular setting out a gradual roadmap towards treating AT1 bonds as higher maturity products with the 100 year rule taking effect from April 2023. However, debt schemes with such bonds may have to deal with a certain level of revaluation risk.

Second, a surge in inflation in India or US bond yields may push yields higher, particularly in the short-term. “Debt funds face an unprecedented situation—very low yields on shorter duration high credit paper and longer paper having unknowns like rise in US bond yields, anticipated growth with increase in inflation, reduced appetite for increased government borrowings adding to volatility—as seen in low returns in the past eight months. In fact, in some schemes, higher expense ratios may have to be brought down. For now, conservative investors could stick to lower maturity funds, or 12-24 months roll down products, to take advantage of possible higher resets in future along with lower volatility," said Chetan Gill, a Chandigarh-based mutual fund distributor.

Prableen Bajpai, founder, Finfix Research and Analytics said: “While we have seen some spike in yields, it is important for investors to understand that there will be volatility in debt funds given the macro environment and situation in the bond markets. Investors with a 3-year horizon can choose schemes with lower modified durations to ensure the holdings of the portfolio are repriced faster as the interest rates begin to rise," she said.

Third, there are large sections of investors waiting in liquid funds, money market funds or similar categories for whom switching to longer duration categories in the current fiscal can incur capital gains tax liability. This is because a switch is counted as a redemption for tax purposes. Traditionally, financial experts have advocated aligning the duration of your debt funds to your goals. For instance, parking short-term money in low-duration funds and medium-term money (3-4 years horizon) in categories like corporate bond fund or banking and PSU debt.

Investors evaluating bond yields for a tactical play should also take their own financial goals into account as well as their ability to digest volatility that comes from interest rate or credit events.

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