In an insightful dialog, Gautam Kaul, Senior Fund Supervisor – Mounted Earnings at Bandhan AMC, breaks down how length performs a essential position in enhancing returns throughout a falling charge setting.
From the mechanics of worth sensitivity to technique shifts for numerous investor profiles, Kaul provides a transparent roadmap for navigating bond markets in a altering charge cycle. Edited Excerpts –
Kshitij Anand: For buyers, particularly retail ones, may you give them a small masterclass on how charge cuts have an effect on investor demand for various tenures of company bonds? I’m certain plenty of new buyers—or the Gen Z ones, you might say—won’t relate a lot to how bonds work. There’s typically extra worry than correct information. So, when you may simplify this equation for them, that will be actually nice.
Gautam Kaul: Once you’re investing in any mounted earnings instrument, there are two broad dangers that you’re uncovered to—length and ranking. Ranking refers back to the credit score threat related to the bond. Period refers back to the weighted common maturity of all of the bond’s money flows.
To simplify, the sensitivity of a bond’s worth to rate of interest motion is measured by its length. For instance, if a bond has a length of 1, then for a 1% change in yields, the worth of the bond will rise or fall by 1%.
Equally, if the bond has a length of 10, a 1% change in rates of interest would trigger a ten% change within the bond worth—plus or minus. There’s a little bit of nuance to this, however that’s the essential precept.Why is that this necessary? As a result of when rates of interest rise or fall, the mark-to-market (MTM) affect in your portfolio is ruled by the bond’s length. Bond returns come from two parts: the coupon (or carry) and the MTM affect. Until you’re holding a bond until maturity, your holding interval return consists of the coupon you earn—sometimes the majority of the return and accrued day by day—and any MTM acquire or loss.So, taking our earlier instance: in case your bond has a length of 1 and rates of interest drop by 1%, you’ll acquire 1% from the MTM, along with your common coupon. If you happen to promote at that time, that MTM acquire is realized.
Once we discuss to buyers about mounted earnings, we encourage them to have a look at two dangers: length threat, which drives the volatility of a bond fund, and credit score threat. These are the important thing parameters you must consider earlier than selecting which funds to put money into.
SEBI has helped right here via its categorization framework. For instance, liquid funds can’t put money into devices with maturities past 90 days; low-duration funds are capped at one yr; short-term funds have outlined length bands. So, buyers get a transparent thought of the utmost and minimal length threat a fund could carry.
For instance, short-term funds should keep a Macaulay length between one and three. So, in that case, for a 1% change in rates of interest, your MTM affect may vary from 1% to three%.
Earlier, it was comparatively straightforward to evaluate the length threat of a portfolio however a lot tougher to evaluate credit score threat. You needed to dig into truth sheets and manually test the scores of each holding. However just a few years in the past, SEBI launched the Potential Threat Class (PRC) matrix—a easy but highly effective software.
It requires each mounted earnings fund to outline the utmost stage of length threat and credit score threat it could possibly take.
For instance, if a fund declares itself as PRC “A” on credit score threat, meaning the fund’s common portfolio ranking might be at the very least AAA always. If it’s PRC “B,” then the common ranking have to be at the very least AA.
This provides the investor a transparent sense of the utmost credit score and length dangers related to the fund—two of essentially the most essential parameters when investing in mounted earnings.
So, when you do nothing else, simply have a look at the PRC classification. It offers you a dependable, forward-looking measure of the fund’s threat profile.
Kshitij Anand: Other than that, wanting on the trade extra broadly—do you see the Indian bond market rising as a comparatively secure haven amid the worldwide debt uncertainty?
Gautam Kaul: Oh sure, completely. The truth is, I’d say India is, if not distinctive, actually one of many few economies that gives each macroeconomic stability and excessive yields.
To offer some context—long-term mounted earnings buyers are primarily making an attempt to protect the buying energy of their cash. Meaning incomes returns that beat inflation, which is the holy grail. Attaining that constantly requires macro stability: low fiscal deficit, low and secure inflation, and ideally a manageable present account deficit.
India ticks all these packing containers. Our present account deficit is low and secure. We’re much less uncovered to tariffs in comparison with economies like Southeast Asia or China, which rely closely on manufacturing exports. Our exports are predominantly services-based, that are extra insulated from world tariff points.
Inflation can also be nicely below management—decrease than the RBI’s forecast and nicely beneath its higher tolerance stage. The federal government has been fiscally accountable, decreasing the fiscal deficit yr after yr (besides in the course of the COVID interval, the place even then, spending was focused and managed). They’ve additionally dedicated to bringing down the debt-to-GDP ratio over time.
These are precisely the metrics that any world mounted earnings allocator seems at. Consequently, world buyers have already began viewing India as a set earnings haven, even earlier than our inclusion within the JP Morgan bond index.
Simply contemplate this instance: If you happen to examine two nations—one the place the fiscal deficit is rising from 5.5% to six.5-7%, and one other the place it’s falling from 5.5% to 4.5%—you’d assume the latter is a developed market and the previous an rising one. However in India’s case, it’s the other. That speaks volumes about our coverage energy.
And all of this hasn’t occurred by chance—it’s the results of deliberate, disciplined coverage selections. For a world mounted earnings allocator, this indicators a secure setting with enticing returns.
One other key level: overseas possession of Indian authorities bonds remains to be fairly low—even submit JP Morgan inclusion, it’s below 3%. For comparability, many different rising markets have overseas possession ranging between 5-15%.
So sure, India provides a beautiful macro panorama, a deep and rising market, and loads of headroom for elevated overseas participation. I imagine we’re well-positioned to grow to be a most well-liked vacation spot for world mounted earnings allocations.
Kshitij Anand: Additionally, let me get your perspective on ESG — one of many key themes that has emerged in each fairness and bond markets. Are buyers assigning a valuation premium to corporations issuing ESG-compliant bonds, and what’s driving the rising recognition of those devices?
Gautam Kaul: ESG as a motion — and the market hooked up to it — has gained important traction and momentum within the West. In India, we’re nonetheless at a really early stage of your entire ESG investing platform. Even inside our panorama, fairness is the place we’re seeing extra traction in comparison with mounted earnings.
That stated, we have now seen some non-public corporates issuing ESG bonds. The truth is, the Authorities of India additionally points inexperienced bonds. So, there’s a concerted effort, and naturally, some demand for these devices from particular segments.
From a set earnings perspective, the market remains to be nascent and growing. A lot of the demand for ESG bonds presently comes from overseas buyers fairly than home ones.
I imagine that as consciousness grows, we may see ESG-dedicated funds in India as nicely — both from Indian or overseas buyers — which may additional drive funding in ESG bonds. There may be nice potential right here, however we’re nonetheless within the early days.
Is the market paying a big premium for ESG bonds? Selectively, sure. But it surely nonetheless must evolve right into a extra widespread and customary apply.
For example, the federal government’s borrowing price for inexperienced bonds versus common bonds isn’t very totally different — maybe only a 5-basis level premium.
When inexperienced bonds had been first launched, our sense was that this premium — or “greenium,” because it’s known as — could possibly be a lot greater. Which may nonetheless be the case sooner or later, given the early stage of the INR bond market.
(Disclaimer: Suggestions, solutions, views, and opinions given by consultants are their very own. These don’t symbolize the views of the Financial Occasions)
