bond market news: Lakshmi Iyer on how to make money out of bonds now
How can one make money out of bond yields in the current scenario?
When we are talking about investments in the financial asset class, we are talking about equity and fixed income. Fixed income to that extent is underrated because it is not that fancy looking in terms of returns. If planned well, depending on the risk appetite one has and more importantly, the kind of longevity, one can plan for investments as low as 30 days or 300 days or 3,000 days. That is the beauty of fixed income, specifically in today’s market scenario, from where we were 6-8-12 months back as during this period, interest rates have gone up.
It is important that viewers take this into consideration and make allocations into fixed income not to grow their money. Most importantly, have a more stability orientation in the financial portfolio.
Do you think the interest rate hike by the RBI and the central government has already been factored into a larger bond yield? Should one wait to look for more price hikes or today is the time when one should go ahead if decided?
The first part of what you said is absolutely right, bulk of the rate hikes which have already happened is in the price, what is likely to happen also to a large extent is already there in the bond yields or the bond price. So what are you waiting for? There will be volatility. Investors should keep this in mind that in every investment whether it is equity, fixed income, gold or real estate, there will be volatility but to ride out this volatility, invest in installments. One can do that even for fixed income. We have gone away from where interest rates bottomed out but have we already peaked out in terms of interest rates? The answer is probably no.
So when one is in that little sweet twilight zone it is okay to stagger the investments over the next three to six months to be able to enjoy the benefit of that elevated yield on to your portfolio.
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What kind of bond related financial instruments are we talking about?
Well an entire gamut of financial instruments is available. There are bonds which are issued by the Government of India, there are bonds issued by state governments and there are of course corporate bonds which are issued by public sector and private sector entities in India.
At the current juncture, looking at where each of these are priced, given the absolute yield levels and the relative yield levels, we believe there is a great opportunity for investors to look at sovereign bonds both central and state because it is not a great opportunity to participate in corporate bonds but the gap or the yield differential – which is what we call the spread between the government bonds and corporate bonds – has almost collapsed. Therefore, on risk reward basis, we believe that a sovereign investment today is a far better and superior opportunity in the works and in terms of tenure or duration, we like anything in the three to six year kind of a bucket. So if you want to buy 2025-26 or 2028-28 or funds which have durations around this, go for it.
What kind of an interest are we looking at from these bonds for this tenure?
Currently if you look at funds which are high grade portfolios, have duration of around two to three years which means average maturity of close to four years. The portfolio yields from a mutual fund perspective is close to 6.9-7% and that is pretty much reflective of the market.
Of course, there are vagaries of interest rates which can play to your advantage but that is the prevailing yield. The tenure benchmark government bond in India is currently at about 7.15%.
Will this be a good option for senior citizens to look at bonds for investment?
Senior citizens require regular cash flows and they can also look at this category. Senior citizens with a small risk appetite, should look at debt hybrid funds. The debt hybrid funds are predominately fixed income but they have a small tail end equity component and that is why they are called debt hybrid. One can look at long-term bonds which are five years, seven years, ten years in nature and also look at a combination of these debt hybrid funds to augment a little bit of potential return over a period of three to five years.
Can you explain to us dynamic bond funds and how they work?
Dynamic bond funds are all about being active, active, active. If you have a view that the markets are going to be volatile, it is going to be very difficult for you to keep the precise amount which is true most of the time. Dynamic or actively managed funds seem to be the place to actually put in the money and keep it for a period of two years, three years, four years or five years.
Here, the fund manager or the portfolio manager depending on his or her view on interest rate y moderates or modulates the duration of the portfolio. If the view is that things are looking fine and one can actually buy more bonds with longer maturity, one can enhance the duration of the portfolio. One can also reverse and reduce the duration of the portfolio when one believes the world is almost going to come to an end and interest rates are going to head northward. By doing so, the portfolio manager is actually increasing or decreasing the interest rate risk for the investor.
Some of them choose to do that with credits also but by and large, I am giving you the majority of them, by and large it is done for a duration for interest rate risk management.
So definitely look at actively managed funds. In our experience, typically over cycles, actively managed bond funds or dynamic bond funds have the potential to outperform passive or the benchmark funds.
What kind of global triggers impact the debt part of the portfolio?
Every global trigger that impacts a financial market, has to impact fixed income also. So to start with, if there is a massive inflation, like we are seeing in the western countries, the tendency of those central bankers – be it in the US or the ECB is to hike interest rates faster. Now that acts as a very strong headwind for domestic bond yields also and so that is number one.
Number two is commodity prices, specifically crude oil and to some extent gold, because these are our two prime import commodities. As these prices go up, you do not consume gold more but for crude oil, we are agnostic of the price. So we keep buying more when it is low, high, whatever. These commodity price trends globally because we are price takers and not price makers.
Lastly, geopolitical issues. Whatever is happening in the globe, if there is disruption on any of these whether it is commodities or any supply chain, all of these blended together give some sort of direction or anchor over and above the domestic factors.
Sometimes domestic factors have a predominant bearing compared to offshore and vice versa so degrees might vary but certainly they do impact bond yields as well.
Let us talk about a few myths that we should bust on when it comes to investing in bonds. A lot of people think that fixed income usually does not offer growth opportunities, how true is that?
As I said earlier, if you are looking at growth route then you have to try to get the cycle of interest rate in terms of timing right which means you are trying to enter at the peak of the rate cycle and then try to ride it through where interest rates are easing; then there is a potential opportunity.
On a consistent basis if you are talking about compounding effect on your money, it is asking a bit too much for fixed income to be able to generate that. Given that we already have a 5-6% kind of a steady state inflation in our system, the tendency to pull down rates beyond a particular threshold will be very limited.
So for some bit of stability of your returns profile on your financial portfolio fixed income, I actually call it the new bunny of your portfolio. It does not have a theme so it does not have the energy boosters to be able to multiply wealth at a pace which equity can potentially do.
What about liquidity, fixed income is always less liquid than equities. Is that true?
Secondary market liquidity for government bonds is absolutely fine, no worries at all, corporate bonds relative to government bonds certainly the liquidity is relatively low which is why we tell investors that participate through open ended mutual funds. The portfolio managers are doing just that, managing your interest rate risk, managing your liquidity risk because you have daily payout funds, it is a daily entry exit funds, open ended funds and then of course when you manage the credit risk so it is a troika of risk which you have to manage and keep in mind among other risks when you are investing in fixed income. So keep that in mind when you are using your vehicle to participate in fixed income. Mutual fund is one such vehicle.
This is all a part of your risk appetite if at all you are investing in a fixed instrument. What about age because in equity usually the thumb rule says that higher the age, the lower the exposure in equity. Is it the reverse when you invest in fixed income?
If I am an entrepreneur who has sold my business at a very young age and made tons of money and do not have any wish or will to really grow it even more and I am doing some other tertiary business, then my only objective is to preserve that wealth. So despite the fact that you are very young and whatever age you are, the primary objective is preservation of the wealth that you have created. But for that kind of an investor, fixed income plays a predominant role.
So age is a necessary condition, but not a sufficient condition to determine how much of money should actually go into fixed income.
In the end, higher reward needs higher risk even in fixed investment?
Definitely, you know, the more you sweeten your rasagullas the tastier it gets. Yes, the potential to earn that additional return is definitely higher but bear in mind that the faster you zoom past 100-120-130 km an hour, the higher are the chances of an accident – in this case, credit default.
So with higher risk comes the potential for higher return and equally high are the risk hazards. Keep that in mind and weigh your balances likewise. In the duration, the higher you go, the chances of making money in a favourable interest rate scenario is reasonably higher.
In the global scenario what is actually concerning for you when you talk about UK and the entire euro zone right now?
Right now the biggest worry is how much higher can these policymakers take their interest rates. That is very important because inflation is going ballistic whether it is in the US or Europe. Most of these economies are likely to hike their interest rates by 50 to 75 bps in the upcoming policy. That is not really true for India but India cannot avoid impact given that it is part of the emerging markets piece. When a developed economy does something like that, especially the US, their currency starts getting stronger. These are factors which we cannot ignore.
We will act obviously on the basis of our ailment which is significantly less severe than in the West and so the medication is going to be different. But we need to be mindful. Even a viral fever needs some treatment.