By: Tavaga Research
With a change in market conditions and an expected rise in yields, earning returns from long term debt funds would be a challenge for investors in the short term. So, a bond investor shouldn’t expect quick gains in a constant maturity gilt fund or staying put in a gilt fund to achieve short-term goals if the yields continue to spike.
Tavaga assists its clients to invest in short-term, tax-free maturity bonds that offer better risk-adjusted returns. By getting in touch with Team Tavaga, controlled and conservative investors can look at building a tax-efficient core debt portfolio.
Why is this shift in an investor’s portfolio so important today?
As India reels from the impact of the Covid-19 crisis, what the economy really needed from the government was to spend. Spend for revival, to bring the economy right back on track, and to foster growth. That’s exactly what the Finance Minister, Nirmala Sitharaman conveyed with her budget presentation. The budget for FY 2021-22 indicated a fiscal deficit of 9.5% for FY21 which would gradually be brought down at 6.8% of GDP for FY 21-22.
The government aims to meet this deficit with the help of a string of operations such as leasing out of infrastructure projects related to roads, railways, and airports, asset monetization, and the sale of other assets that are owned by them. Privatization of two public sector banks, as well as the long-awaited Initial Public Offering (IPO) of the Life Insurance Corporation of India (LIC), would also be taking place in FY 22. Furthermore, the government plans to disinvest its holdings in CONCOR, SAIL, and BPCL.
Along with the above-mentioned divestments, the government plans to borrow an additional Rs.80,000 crore from the market in the financial year.
What is the impact of a high fiscal deficit?
A fiscal deficit explains how much the government would have to borrow funds from the market to meet its expenditures. This borrowing is done by issuing and selling bonds. Borrowing by the government, however, has a crucial impact on bond yields.
The impact on short-term yields is minimum, as they reflect the effect of the monetary policy and as well as cyclical conditions. For long term yields, two factors would come into play. One factor that is known to all would be inflation. The second factor would be the anticipation of higher fiscal deficits and hence, more debt.
How would the yield curve look in such a situation?
As the government borrowing increases, bond yields go up. As can be seen in the chart above, a steady reduction in the yields for bonds with different maturities can be seen, with a fall in the fiscal deficit. The current fiscal deficit pegged at 9.5% of GDP therefore, will be followed by an increase in yields of long-term bonds. So an upward sloping yield curve is what investors would see at least in the short term.
What does this mean for debt fund holders?
An increase in bond yields means a reduction in the prices of the bonds. This reduction in the price of the bond would broadly affect debt fundholders, as there would be an erosion in the Net Asset Values (NAVs) of these funds.
Furthermore, this would also lead to a reduction in wealth for retail as well as institutional investors. The higher impact would be seen on funds that hold bonds with longer maturities versus those who hold short term bonds that are closer to maturity. An increase in yields would also, in turn, increase the yields for corporate debt funds as well; they usually offer yields higher than those on government securities.
The government has proposed to introduce a framework to buy debt securities that are of investment-grade to deepen the corporate bond market. This would instill further confidence in market participants as well as increase liquidity in secondary markets. Such a move will contribute towards pushing down yields, further benefitting debt fund investors.
Next step for investors
Investors should think about considering short term, ultra-short, liquid bond funds to park their money in. Increasing yields combined with the impact of inflation could lead to a potential loss of capital.
Debt funds that invest in shorter maturity securities, can manage to escape the impact of longer-term depreciation of yields. They will help protect investors from the volatility in the market.
However, it is important to note that a short-term debt fund is not always a safe instrument to invest in. The classic case in this category is that of the various debt funds that were closed for redemption by Franklin Templeton due to the underlying defaults. Therefore, consulting a SEBI Registered Investment Adviser is necessary during every investment.
Moreover, if an investor has a long-term goal (of more than 4-5 years), he/she should continue investing in constant maturity gilt funds for risk-free returns.
Some options suitable for long term investments in bonds, available on the Tavaga App
5.85% G-Sec maturing in 2030
The government of India launched the 5.85% GS (Government Security) 2030 on 1st December 2020. The duration of the bond is 10 years, offering a coupon rate of 5.85% that would be paid on a bi-annual basis. It is currently priced at Rs. 1,000 per bond.
4.48% G-Sec maturing in 2023
The government launched the 4.48% GS (Government Stock) 2023 on 2nd November 2020. The duration of the bond is of 3 years with a coupon rate of 4.48%. The coupon payments would be half-yearly, and the bond is currently priced at Rs. 1,011 per bond.
Indian Railways Finance Corporation (IRFC) maturing in 2024 (Tax-free
The IRFC bond, launched on 18th February 2014 has a duration of 10 years. The bond is tax-free and has a coupon rate of 8.48% paid yearly, with an effective yield to maturity of 4.40%. It is currently priced at Rs. 1,196 per bond.
Sovereign Gold Bond (2.5%)
The Sovereign Gold Bond Series 4 (2020-21) was launched by the RBI on 14th July 2020, with a duration of 8 years. The coupon rate for these bonds is 2.5% that is paid on a half-yearly basis. It is currently priced at Rs. 4,830 per gram.
The RBI opened Series XI for the sovereign gold bonds on 1st February 2021, which are currently priced online at Rs. 4,862 per gram. Comparatively, the sovereign gold bonds offered on the Tavaga platform are available at a discount, priced lower at Rs. 4,830 per gram.
Tavaga is everything you need to start saving for your goals, stay on track, and achieve them in time.