Several fund houses have launched these funds with the expectation that the rate cycle is in its final phase
17-Jan-2023 •Chirag Madia
Fund houses are humming about long-duration debt funds as they believe the interest rate cycle has peaked, but we remain cautious.
Prominent fund houses such as Axis Mutual Fund, SBI Mutual Fund and HDFC Mutual Fund have recently rolled out long-duration funds, with Devang Shah, the co-head of fixed income at Axis, telling us they "don't expect significant rate hikes" in 2023.
He further said this could "potentially be a better entry point for investors with long-term fixed-income" needs, given the "current long-term G-Sec bond yield levels".
Relationship between long-duration funds and rising rates
Last year, the Reserve Bank of India raised interest rates by 2.25 per cent to tame inflation, the most aggressive monetary tightening exercise since 2011.
When interest rates rise, the popularity and price of existing bonds held by debt funds go down. That's because the interest these bonds provide is less than what the market offers. On the other hand, the freshly-issued bonds start giving higher interest rates, compelling debt funds to stock up on them so they can minimise the impact of older issues.
In short, debt funds with longer maturity are vulnerable to interest rate changes. The longer the maturity of a debt fund, the more chances of interest rate fluctuations.
Despite last year's volatility, fund houses have launched these long-duration funds with the belief there won't be more than one round of rate hikes in 2023.
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Case for roll-down strategy
Fund houses like HDFC Mutual Fund are launching debt funds that will mature in 2050-2055, but they provide comfort to prospective clients by saying they'll follow the roll-down strategy.
A roll-down strategy is relatively risk-free as it allows funds to, by and large, hold their investments until maturity. This helps debt funds to increase predictability in returns like, say, a fixed deposit.
However, this strategy works if you are willing to stay until the maturity of the investment. If you plan to withdraw your money before that, you'd be prone to interest rate volatility.
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