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News flow around index inclusion has periodically generated frenzy and despair in bond markets over the past few years. In this context, one may look at additional ways to promote domestic retail demand for government securities (G-Sec) including SDLs (state development loans). As per June 2022 data from the Reserve Bank of India (RBI), mutual funds own around 2.32% of outstanding G-Secs, 1.89% of SDLs and 14.86% of Treasury Bills. The space for direct ownership of these through MF schemes remains appealing and holds a lot of potential. Apart from the tax efficiency, the broader theme remains that of owning a credit risk-free asset class at relatively attractive yields. It may be time to revisit these as one makes an asset allocation decision.
Phase of interest rate cycle: With the RBI having hiked policy rates by 190 bps and normalized liquidity substantially, one could expect that the policy tightening phase is close to peaking. An uncertain external environment could potentially keep market conditions volatile even in the near term. A staggered approach to investment in G-Secs can be an option for investors.
Real rates: CPI inflation rate based on RBI data is expected to average around 6.7% in the current financial year (FY). Q1FY24 CPI inflation is estimated at 5% by the RBI, and most CPI projections for FY24 center CPI at 5.0%-5.5%. The sovereign yield curve currently provides a forward-looking real positive yield across all tenors even assuming that medium-term inflation stays at the upper end, i.e 6%, of the RBI’s target range. One -year treasury bills trading today at around 6.80% provide a prospective real return of around 1.59%, assuming one-year ahead inflation of 5.20%.
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Credit spreads: Investments in debt securities with credit risk element such as corporate bonds are based on a suitable mark up over the comparable maturity G-Secs. This is to compensate investors primarily for the additional credit risk, apart from the illiquidity factor. The exigencies of the post-covid financial landscape led to massive injection of liquidity. This led to a material shift in corporate borrowings towards the bank loan segment. A surge in excess liquidity, and less supply of bonds alongside regulated demand has led to bond spreads tightening materially. Considering the current market rates as well as spreads, G-Secs present a clear case for additional ownership (see table).
Access options: A most common lament has been that government securities are volatile, thereby keeping investors away from government security funds. However, this argument seems not to factor in price volatility across all other asset classes. At the same time, investors have multiple options to access G-Secs through the MF route such as open-ended actively managed gilt funds, target maturity index funds as well as closed-ended funds such as fixed maturity plans, or FMPs.
• Open-ended gilt funds: These products provide investors the access to an actively managed portfolio of Sovereign securities. Since these products take larger duration risks, one needs to factor in their risk tolerance and the holding period.
• Target maturity index funds: These, with the G-Secs as an underlying securities, provide the benefits of defined maturity, liquidity as well as a broadly predictable yield based on the market yields at the time of investment. Investors have the benefit of taking exposure to their preferred maturity segment.
Attractive yields on a relative basis, current macro backdrop and a range of products provide retail investors with options based on their risk appetite to access a credit risk-free asset in a tax efficient manner. This is an appealing opportunity for investors.
Rajeev Radhakrishnan is CIO – Fixed Income, at SBI Mutual Fund
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