Long-term portfolios poised to generate favourable returns

Diversification across bond types, sectors and issuers is crucial to spread risk effectively.

Investors should now bet on long-term debt mutual funds to seize the opportunity to reap capital appreciation. As the interim Budget has set lower borrowing target for next fiscal, it will reduce the supply of government paper and push down yields. And when bond yields fall, prices rise and long-term bond funds benefit the most.

Experts say investors should consider betting on long-term debt funds after the Budget for several reasons. For one, the projected fiscal deficit for FY25 and the expected decline in gross market borrowings indicate positive prospects for the bond markets.

Secondly, the Reserve Bank of India’s consistent pause stance since April 2023 and the global bond inclusion will further enhance the flow to the debt segment, drive up demand and bolster investor confidence.

Nirav Karkera, head, Research, Fisdom, says these trends suggest that bond yields are likely to decrease further, potentially leading to capital appreciation for investors. “These factors collectively strengthen the case for investors to consider long-term debt funds, presenting an opportunity for potential capital gains,” he says.

Similarly, Soumya Sarkar, co-founder, Wealth Redefine, says with reduced government borrowing, bonds are likely to become softer, leading to a decline in their value.

“Long-term portfolios are poised to generate favourable returns. Investors may find it opportune to allocate funds to long-term bond funds taking advantage of the softened yields in the bond market,” he says.

Adopt a barbell strategy

While the current interest rate environment may seem favourable, it’s important to avoid allocating the entire investment portfolio to securities with higher maturities. Fixed-income investments primarily aim to mitigate overall portfolio risk, rather than solely focusing on appreciation. Investors should not rely on rollover risk as the sole parameter when constructing their debt portfolio and and should keep in mind other macro factors including credit quality, duration, market conditions, macro environment and investment goals, to ensure a well-rounded and balanced approach to debt portfolio construction.

Karkera suggests that investors should adopt a barbell strategy. “They should allocate 40% of their funds into short-term options, such as target maturity funds, to minimise rollover risk. They should allocate the remaining into gilt-oriented funds with longer durations,” he says. “This balanced approach helps investors achieve diversification while effectively managing the maturity risk in their debt portfolio.”

What to keep in mind

Before investing in long-duration funds, investors should assess the fluctuation of yields, observe whether they are trending upward or downward. The prevailing trend indicates a downward trajectory in yields. They should carefully assess the current interest rate environment, considering both the potential for capital gains in a low-interest-rate environment and the risk of losses if rates rise.

Diversification across bond types, sectors and issuers is crucial to spread risk effectively. Comparing expense ratios and aligning investment goals and risk tolerance are also essential steps to ensure that investors select funds that suit their financial objectives and are comfortable with risk.

In the current scenario where yields are decreasing, investors should opt for high-yield investments. Despite the rollover risk, this option holds appeal as it allows investors to secure higher yields now. “Given that new bonds will likely have a lower yield-to-maturity (YTM), locking in high-yield products enables investors to capitalise on prevailing rates and benefit from potential future rate cuts,” says Sarkar. This strategic move positions investors to enjoy favourable returns amidst the evolving market conditions.