NEW DELHI: Investors should lower their return expectation from debt funds as the potential for capital gains will be limited going forward, according to Pankaj Pathak, fund manager-fixed income, Quantum Mutual Fund.
In the near term, the bond market is expected to take cues from the developments in the money markets and the Reserve Bank of India’s (RBI) response to it. Core liquidity surplus has risen to over Rs11 trillion as of now from Rs7 trillion at start of the current fiscal.
According to the fund house, such excess liquidity could limit RBI’s capacity to buy bonds and foreign exchange.
“This is a significant risk for short-end bonds which are richly priced at current levels. On the other hand, the long end of the yield curve still offers a reasonable valuation considering the terminal repo rate may remain below its pre-pandemic normal,” Pathak wrote in a note.
Another positive for long-end bonds is the government’s fiscal position, which has been supported by significantly higher tax collections.
Experts say that long-term bonds are expected to gain more in case of a borrowing cut.
Quantum Mutual Fund has, however, warned that there remains high uncertainty about the future trajectory of interest rates.
“The biggest risk for bonds would be a change in RBI’s view on inflation being ‘transitory’. There is also a threat of faster normalisation of monetary policy in developed economies which could cause turbulence in emerging countries like India,” Pathak said.
For long-term asset allocation in fixed income space, he suggested that investors should go with dynamic bond funds over longer duration funds.
However, for any such allocation, investors should be prepared to hold for a longer time horizon while also tolerate some volatility in the intermittent period.
Conservative investors should stick to categories like liquid funds that invest in very short maturity debt instruments and tends to benefit from rising interest rates, experts said.
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