A bumpy ride ahead for gilt funds

The yield on 10-year G-Sec has inched up over the past month

It was a rocky 2018 for long-duration gilt funds, as the yield on 10-year government securities remained volatile through the year. After a lacklustre 2017, gilt funds —that invest primarily in long-duration government bonds — delivered just 6-odd per cent returns, on an average, in 2018. While bond prices did spike towards the end of 2018, it was short-lived. Since February, the 10-year G-Sec yield has been trading in the 7.2-7.4 per cent range. The recent policy rate cut by the RBI in April has also not cheered bond markets, leaving gilt funds with a jaded performance.

Uncertainty over inflation and fiscal worries are likely to add pressure (upward) on bond yields. Given that longer duration bonds are more sensitive to rate movements, gilt funds investing in them could be in for a bumpy ride this year.

Volatility in yields

Until September-October last year, concerns over inflation, tightening global liquidity and the RBI hiking its key repo rate (from June 2018) had led to rise in interest rates. G-Sec yield had peaked at 8.1 per cent in September. Gilt funds, until October, had delivered just 2-4 per cent returns. The RBI bringing in measures to ease liquidity, coupled with the announcement of several open market operations (buying of government bonds), had soothed bond markets subsequently. The yield on 10-year G-Sec fell sharply to 7.2 per cent levels by end-December. Gilt funds made hay during this period, delivering a tidy 3-4 per cent return in just three months (between Nov 2018 and Jan 2019).

But the euphoria was short-lived. Even as the RBI cut short its rate hike cycle abruptly and cut its repo rate in February this year, bond yields have been treading gingerly.

While a favourable inflation over the past few months has raised hopes of further rate cuts by the RBI, concerns remain. Possibility of low food inflation inching up, a sticky core inflation and the recent hike in crude prices are keeping bond markets on the edge. More importantly, fiscal worries are exerting upward pressure on bond yields.

Hence, since February, gilt funds have delivered modest 1-2 per cent returns.

Funds’ performance

Amid volatility, there have been a few funds that fared better over the past year. Reliance Gilt Securities, IDFC G Sec Fund - Invst Plan, LIC MF G-Sec Fund, Aditya Birla SL Govt Securities Fund and DSP Government Securities delivered 8.5-9.5 per cent returns over the past one year.

Fund managers mitigate the rate risk in gilt funds by reducing the maturity of the portfolio when rates rise. Most of these funds reduced their portfolio’s average maturity significantly in 2018 to tide over market volatility. From 8-10 years in Jan 2018, these funds have reduced their maturity to three-five years by October.

Most funds did not increase their maturity in the short period of rally between Nov 2018 and Jan 2019. Many upped their maturity to about seven to eight years by March 2019, possibly on rate easing expectations. But the market has once again turned cautious over the past month. Given that the yield on 10-year G-sec has moved up by 20 bps since the beginning of April, owing to growing concerns on inflation and fisc, it is likely that many funds will tinker with the maturity of the portfolio to cap losses in the coming months.

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