 |
| Capitalstars Investment Advisor |
The Reserve Bank of India (RBI) announced an unusual set of operations—that it was selling government bonds maturing in 2020 and buying those maturing in 2029. RBI repeated this action on 26 December, to be conducted on 30 December. RBI’s initial action, now popularly called Operation Twist, was seen as the Indian version of an action undertaken by the US Federal Reserve in 2011 as part of its efforts to revive the economy hit by the global financial crisis.
Though the amount involved in Operation Twist— ₹10,000 crore each in the two actions—is modest, many market participants feel such actions can have major implications for the debt markets and interest rates. This can, in turn, affect debt mutual funds because their returns increase when interest rates fall and vice-versa.
Operation Twist involves the buying of long-dated bonds and selling of short-dated ones by RBI. This will do two things, said experts.
“It will lower the term premium and will benefit investors in longer maturity funds," said Dwijendra Srivastava, head, fixed income, Sundaram Mutual Fund. The term premium is the extra yield that bonds with a longer maturity payout. This is because investors see longer-dated bonds as riskier and demand higher yields for holding them. For example, three-year bond yield is around 6.5% but a 10-year bond yield is close to 7.5%. Operation Twist aims to reduce this spread, bringing down the cost of long-term borrowing.
“Operation Twist attempts to get yields of long-term bonds lower without any rate cuts," said Arvind Chari, head, fixed income and alternatives, Quantum Advisors Pvt. Ltd. RBI paused the rate cut cycle in its 5 December monetary policy. Lower rates raise the prices of these bonds and hence the returns of debt funds holding the bonds. These include medium-term, long term and government securities (gilt) funds.
The extent of the sensitivity of a fund to interest rate changes is measured by the modified duration. This gives the percentage change in a debt funds’ value in relation to the percentage change in interest rates. For example, a modified duration of five means that a 1% fall in rates will cause a 5% jump in the value of the fund’s portfolio, other things being equal.
Many hybrid funds also hold long-dated bonds and their returns are affected by rate changes. “If such moves continue, bond yields may fall by up to 20 basis points," said Srivastava. Investors in long-dated funds may benefit from a further fall in yields as a result of Operation Twist.
Over the past year, interest rates have fallen by a significant margin. The yield on the benchmark government of India bond has fallen by 7.30% to 6.60%, a drop of 0.70% (as on 24 December). This has caused a rally in long-dated funds. Gilt funds which invest in long-dated government bonds have delivered 10.12% over the past year compared to their five-year average return of 8.08%. At the same time, long-duration funds have delivered 12.12% compared to their five-year average return of 8.76%.
Within days of RBI’s announcement of Operation Twist, yields on 10-year government bonds fell from 6.75% (on 19 December) to 6.58% on 24 December. Long-duration funds, on average, rallied by 1.88% over the same period and gilt funds shot up by 1.10%. If RBI were to conduct more such operations, these categories of funds may see similar gains in the near future.
We will be happy to help you to select your mutual fund plan. Get more details here: Mcx Tips, Derivative-Free Trial, Stock tips Call on:9977499927
Capitalstars is a SEBI registered investment advisor. Schedule a call with Capitalstars investment consultant or drop a mail at backoffice@capiltalstars.in and we will get in touch with you. You may also call us on 9977499927
Investment trading in securities market is always subjected to market risks, past performance is not a guarantee of future performance. CapitalStars Investment Adviser: SEBI Registration Number: INA000001647
For more details call on 9977499927 or visit our website www.capitalstars.com
