The RBI raised the repo rate by 0.25 per cent, making debt mutual funds volatile. Abhishek Bisen of Kotak Mahindra AMC said, "the bond market is already factoring in nearly 100 basis points of repo rate hikes." Investors should use short-duration funds through SIPs as markets work to get stable.
The rise in repo rate by 0.25 per cent by RBI will reduce the net asset value and yield trajectories of fixed-income mutual fund schemes in the short term.
Whenever RBI raises the benchmark repo rate, borrowing costs increase across the banking and debt capital ecosystems. Hence, the government securities and corporate papers issued after the rate hike carry higher coupon rates to move in tandem with the higher repo rate. This makes the coupon rate of existing bonds held by investors seem relatively lower, which then reduces their value in secondary market trading.
Mutual funds are mandated to value their debt holdings on a mark-to-market basis every day, and thus a decline in bond prices translates directly into lower net asset values for existing investors.
RBI policy stance
Moreover, RBI has changed its policy stance from ‘neutral’ to ‘calibrated tightening,' which reflects the central bank's commitment to an extended period of tightening.
Abhishek Bisen, Head of Fixed Income, Kotak Mahindra AMC, said while the 10-year G-sec yield moved higher after the RBI’s rate hike, the 30-year yield softened marginally, suggesting investors believe most of the tightening cycle may already be priced in.
Currently, he said the bond market is already factoring in nearly 100 basis points of repo rate hikes (including 25 bp delivered), so a hawkish signal is not entirely unexpected.
Investors should avoid reacting to a single policy move and increase exposure to high-quality short- and medium-duration funds through SIPs, he added.
Sandeep Agarwal, Head of Fixed Income, Sundaram AMC, said while the change in policy stance from “neutral” to “calibrated tightening” was a surprise move, it suggests that the rate cycle is yet to peak.
Near term
In the near term, he added investors may gravitate towards lower-volatility categories such as ultra short term, money market funds, or other short-term investment opportunities. Over time, as markets stabilise, higher accrual yields are likely to enhance the attractiveness of debt funds and support higher inflows, he said.
Subhendu Harichandan, Executive Director, Anand Rathi Wealth said the change in RBI stance shows its willingness to take a difficult decision to bring in price stability while navigating the current challenging market conditions.
While there can be some pressure on the NAVs of debt funds in the short term, he said short- and medium-duration funds are in a better position because they can reinvest at the new, higher rates, even as long-duration funds can see more volatility in the near term.
Piyush Jhunjhunwala, Founder and CEO, Stockify, said when yields go up, investors may get a chance to invest in the market at higher interest rates, subsequently enhancing their portfolio’s potential return.
For investors, he said, while higher yields may present certain challenges, it does not have to translate into negative experiences with debt funds, as fresh investments will benefit from better rates.