How to maximise returns from debt portfolio

Within the present fastened earnings market, yields throughout the curve have bottomed out and the yield curve is extraordinarily steep. Prevailing time period yields for AAA PSU Bonds as on 4th Jan’22 as per Bloomberg are 4.66% for one 12 months, 5.57% for 3 years, 6.16% for 5 years and seven.03% for ten years.

As charges rise going ahead, the yield curve is predicted to flatten, which implies that the shorter finish of the curve (1-3 12 months) is predicted to rise quicker than the longer tenures (10 12 months).

Throughout the IL&FS disaster in November 2018, the yield curve was flat and yields had been a lot increased. As an illustration, the one-year AAA yield & the 10-year AAA yield had been each at 8.8%.

Previous to the pandemic, a easy technique of holding a debt fund with underlying credit score high quality being AAA and three-year maturity would have sufficed to beat retail inflation, which usually averages at 6% each year in India.

Nevertheless, with prevailing yields being so low, this technique wants a whole overhaul.

Quick maturity funds aren’t ample to beat inflation, whereas having solely lengthy period funds (10 12 months maturity) poses excessive rate of interest sensitivity and is topic to excessive volatility.

A ‘Barbell’ fastened earnings funding technique includes making a portfolio with a mix of brief time period debt devices and long run debt devices to get an optimum mixture of yield and period (rate of interest sensitivity).

In right this moment’s context, we propose making a barbell portfolio the place (i) 65-70% must be invested in AAA-oriented roll-down technique funds with 3-5 12 months maturity the place yields are within the vary of 5.50-6.00% p.a., and (ii) the stability 30-35% might be invested in AAA-oriented roll-down technique funds with 10 12 months maturity the place yields are nearer to 7% p.a.

This may successfully present a portfolio the place the weighted common maturity profile is round 5.5 years (i.e. period of ~4 years), and importantly the yield might be barely increased than 6% p.a.

On the similar time, roll-down methods would make sure that rate of interest sensitivity or portfolio period retains decreasing with each passing 12 months.

Passive roll-down debt funds, e.g. Bharat Bond funds, PSU Bond plus SDL funds, are greatest suited to assemble such barbell portfolio technique as their portfolios consist solely of AAA-rated devices and State Improvement Loans (SDL), the latter being at par with G-secs in relation to sovereign credit score.

Notice that this technique is usually recommended for these traders with minimal three-year funding horizon. Debt funds should be held for 3 years to qualify for long run capital features tax at 20% with indexation profit.

(Nitin Shanbhag is head of funding merchandise at Motilal Oswal Wealth.)

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