Bond investment – why now may be the right time?

It’s a question of when and not if. Most indicators point towards the Reserve Bank of India starting the interest-rate cutting sooner rather than later. Globally, the US Federal Reserve and the European Central Bank have pivoted. Last month, the US central bank, popularly known as the Fed, started its rate-easing cycle with a 50 basis points reduction, first since the onset of pandemic in March 2020. 
 

The Fed’s action accelerated a so-called bond rally as investors flock to these fixed income instruments to lock in their investments before further easing by the Fed. The demand is also partly fueled by Dithe geopolitical crisis in West Asia as bonds are considered as safe-haven assets. 
 

The global interest rate easing coupled with easing domestic retail inflation has boosted prospects of a rate cut by the RBI. However, investors will have to wait for a little longer. Most economists expect the easing cycle to start in December because the central bank would like to see whether the fall in inflation is sustained. 
 

But investors have reasons to bet on Indian bonds, which are currently at an attractive intersection.  Here is why:

RBI’s action – 

Bond yields, which are inversely related to bond prices, are already factoring in a rate cut by the RBI. Bond market participants expect the yield on benchmark 10-year government bonds to ease to around 6.5-6.6% by the end of March. Change in the broader interest rate is the most critical factor that influences investment into bonds. Interest rate and bond prices are inversely related. In the easing cycle, bond prices rise (while yields fall) leading to capital appreciation. Easing yields have created ideal time for investors to enter the market and avoid FOMO – fear of missing out.  
 

Demand-supply dynamic –

 Another reason why bond yields are expected to ease is the demand –supply dynamic.  For the second half of FY25, the Indian government has kept the gross borrowing via government bonds unchanged at Rs6.6 lakh crore. This means supply of bonds will remain as expected. But there is more demand, especially from foreign portfolio investors. Since the inclusion of Indian bonds in the global bond index in end-June, investment by FPIs into sovereign bonds has increased by $7.5 bln. Such inflows are expected to remain robust as foreign investors correct their underweight positions.  Foreign investors have also stepped up their purchases of India government bonds ahead of the start of rate easing cycle. The firm demand from foreign investors may lead to fall in bond yields. 
 

Start of the global rate easing cycle increases the appeal of emerging market assets.  Given a stable macro picture, India is a likely beneficiary. In contrast to Fed’s aggressive cuts, the RBI is expected to take a moderate approach for easing of interest rates. This is expected to lead to widening of spreads (differential in US and India bond yields), which in turn may encourage FPIs to bet on Indian bonds. 
 

How to play the bond game in India? 

In India, bond investment is mainly done through the mutual funds route. You can play the interest rate easing cycle by choosing debt funds based on your risk profile. 
Debt mutual funds invest in fixed-income securities like government bonds, treasury bills, corporate bonds, and other money market instruments. There are a variety of debt funds depending on the investment horizon, underlying instrument, and risk-return profile. 

Long bonds -

 Typically, long-duration funds benefit the most in the rate-cutting cycle. It is best suited for investors who have an investment horizon of at least 1 year. Dynamic bond funds, gilt funds, long-term bonds that have higher exposure to 10-15 year papers are suited for such a profile of investors.  Often, ahead of the expected interest rate cuts, investors are advised to add duration or extend portfolio’s duration to benefit from falling interest rates. Duration measures a bond portfolio’s sensitivity to changes in interest rate.  
 

Moderate duration –

 Individuals with less risk appetite, can consider investing in banking and PSU, corporate bond funds. These funds invest in high-quality corporate bonds. With duration of 3-5 years, these funds are suitable for investors looking for stable returns without the volatility associated with long bonds. In fact, once the rate cut cycle starts, investors can move to these funds because short-term rates fall faster. However, there is higher risk associated with corporate bonds, investors must carefully assess the underlying investments and preferably stick to highly rated quality papers. 
 

Tactical strategies –

 High net worth individuals with access to professional advisors can also take tactical calls on bond investment based with an aim to maximum returns. This is done by playing on the interest rate bets and the construct of the yield curve. HNIs can also opt for investing directly in corporate bonds through online bond portals. These online platforms facilitating investment in corporate bonds are gaining traction. They are regulated by the Securities and Exchange Board of India, which provides a safety net for investors. They can also consider investing in government bonds through the RBI Retail Direct platform.