Fixed Income: Continue to Stay at the Short End & Mid Segment

The yields at the short end as well as the long end remained more or less stable in the last two months. The market has been supported by the surplus liquidity conditions all this while and this may continue to be the singular factor deciding the course of the markets in the future too. While the long end of the curve especially the 10-year benchmark has remained within a narrow range for most part of this year, that is, between 5.80 % and 6.20 %. Significant fall in the rates happened at the short end of the curve if you look at the one-year CD and CP rates. This again is based on the soft money policy of the central bank and the liquidity injection that has been happening through the targeted repo operations.

The accommodative policy of the RBI is likely to continue till growth starts picking up and normalcy returns to the economic activity. But there are a couple of factors that should be kept in mind while taking a view of the fixed income market. First of all, the rate of inflation indicated by the consumer price index still continues to be high, higher than the threshold set by the RBI. This is coming from not only food inflation but also from a number of other components of the index. A persistence of this price rise may compel the RBI to moderate the liquidity support over time. Brent has been rising recently and this upward trend in oil prices may remain intact in the immediate term and this could fuel further inflation across segments. Therefore, threats on account of rising price level remains a little elevated compared to any time in the recent past. These factors could trigger some pressure on yields. One factor that has been a great consolation for the markets is the huge inflows of liquidity which has been coming into India from overseas investors. This liquidity is being sterilized by the RBI to some extent, but the point is that flows of such magnitude generally lead to softening of yields. But with the domestic liquidity which itself caused a softening in the last seven to eight months the scope for any significant softening remains seriously limited.

The recommendation given during the course of the last one year has been to stick to the short end of the curve and to avoid the long duration products. We continue with the same advice for fixed income investments. This approach has paid good dividends. The investments into the recommended Banking and PSU Debt Funds, Short Duration Funds, and Corporate Bond Funds generated returns in the range of 10 to 12 % while if one was to stay in gilt funds the returns would been around 13 % to 14 %. On a risk adjusted basis, the returns from the shorter maturity funds is far superior.

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