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Planning to invest in gilt funds? Invest at your own risk... - Outside View by PersonalFN

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Planning to invest in gilt funds? Invest at your own risk...
Apr 26, 2014

Yield on 10 year-benchmark government bond touched 9.10% mark last week. This was the highest level seen since the beginning of 2014. When bond yields go up, bond prices fall and when bond yields move down, bond prices rise. This clearly suggests that bond prices of 10-Year benchmark government bond have fallen since the beginning of this year.

Are Indian treasuries attractive?
Source: Economictimes.com

Some of you might believe that taking advantage of spike in the yield would be rewarding. However, PersonalFN feels the contrary.

Why you shouldn't invest in gilt funds for now?

Easiest way to take exposure to government bond market is to invest in Gilt funds. Bonds and bond yields move in opposite direction. Due to following factors PersonalFN believes investing in gilt funds may not be appropriate now...

High fiscal deficit: In simple terms, fiscal deficit means excess expenditure of the government over and above its revenue. Government has disappointed on this front. Fiscal deficit for first 11 months of the Financial Year (FY) 2014 came in approximately at 114% of the target. Higher than expected fiscal deficits, push the yields up.

Threats of sustained inflation: High food price is putting pressure on overall retail inflation. For the month of March, retail inflation came in at 8.21%. Industrial inflation as measured by Wholesale Price Index (WPI) rose to 5.7% in March as against, 4.68% recorded in February.

Unsupportive monetary policies of RBI: RBI has set a target of 8% retail inflation for 2014. In its first bi-monthly monetary policy, RBI kept policy rates unchanged. It seems to be waiting for the new government that comes to power at the centre; and its policies with respect to growth and inflation. Usually when RBI reduces policy rates, bond yields move down. On the contrary, when RBI raises rates bond yields move up.

Huge borrowing calendar of the government: The central government is expected to exhaust around 62% of the borrowing target set for 2014-15 within first 6 months of this financial year. There may not be enough buyers to absorb fresh issuance of government debt. And investors may ask for higher rate. Lately it was observed that, banks and other institutional investors sold 10 year-benchmark government bond.

What to expect?

Considering heavy bond auctioning programme and relatively constrained liquidity situation, yields may not come down significantly. Sentiment of the investor is not expected to improve much, unless inflation slows convincingly and RBI monetary policies turn supportive. Markets would seek clarity on fiscal management and broader economic policies of the new government. On the other hand, if RBI infuses liquidity through Open Market Operations (OMOs) yields may see a drop.

End Note:

PersonalFN believes investors should stay away from gilt funds at least for now. To government bond markets to turn favourable for investors, the new government has to unveil a prudent fiscal management plan. Inflation has to slow down with moderate to positive outlook and finally RBI should bring down policy rates. At present, markets have no clarity on any of these aspects. Better to avoid gilt funds at this juncture. PersonalFN has always believed that only aggressive investors should take exposure to gilt funds. But exposure to such funds should be limited to 20% of the debt component of one's portfolio.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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