Inflation and G-Sec yields remain the biggest risks for bond investors: Sandip Raichura

Bond investors may need to tread with caution as inflationary pressures and movements in government securities (G-Sec) yields continue to dominate the risk landscape.

In an exclusive conversation with ETMarkets, Sandip Raichura, CEO – Retail Broking and Distribution, Director – PL Broking and Distribution, highlighted why these two factors remain the most critical variables for debt market participants and how investors should position themselves amid evolving interest rate dynamics. Edited Excerpts –

Kshitij Anand: Well, let us quickly start with what is happening. There is a lot of volatility, as we discussed before the show, but between gilt funds and corporate bond funds, where should investors allocate money in the current environment?

Sandip Raichura: That is becoming a very relevant question. With government bond yields having fallen over the past couple of years, investors seem to have enjoyed a bonanza in terms of returns.

However, with the RBI moving into what is called a pause in its near-term outlook on rates, yields, and inflation, it is likely that the incremental returns from bond funds may not be as attractive as before. On the other hand, corporate bond funds, especially credit risk funds, have also had a good run as the entire yield curve has narrowed.

We believe one should have a barbell approach. This means that if you are overloaded on corporate bond funds, you should reduce exposure because of the risks ahead. If you are in long-duration instruments, you should possibly move to shorter durations with a heavier tilt toward short-term bond funds and gilt funds.

Roughly, if you ask me, I would suggest 30% in short-term bond funds, including dynamic funds, about 40% in gilt funds, and 30% in corporate bond funds, with one-third of that — roughly 10% of the portfolio — in credit risk.

Kshitij Anand: Why can fixed income act both as a hedge and as a potential risk during volatile market phases?

Sandip Raichura: Equities and debt typically move in opposite directions over the medium term. When the underlying economic impulse is weak — for example, during a demand slowdown, which we may be experiencing in India right now — yields tend to soften.

This means that if you have bought a bond, you would see appreciation in its value. At the same time, weakening economic growth can hurt equities because of its impact on earnings and overall market sentiment. To that extent, there is a natural balance between the two.

We always recommend that investors keep about 5% to 10% of their investable surpluses in liquid and short-term bond instruments. This holds true whether you are a very aggressive investor or a conservative one focused on fixed income, as it allows you the flexibility to average between the two asset classes.

Kshitij Anand: How can investors use fixed income as a temporary parking strategy before allocating to equities?

Sandip Raichura: We are lucky to be in a situation right now with repo rates around 5.5%. Even risk-free instruments like liquid funds and overnight funds are yielding between 5.5% and 6.5% for investors.

So, it makes absolute sense, especially if you are a fixed-income-oriented investor looking at the short term, or if you are waiting for opportunities in equities, or even considering global events like the Trump tariff tantrum playing out.

Over the next couple of months, you should definitely be invested in Indian liquid funds and short-term bond instruments. Given the current uncertainties, if you are a tactical investor, it makes even more sense to look seriously at earning this 5.5%, which, in my view, is a very attractive return.

Kshitij Anand: And in fact, at the beginning of the conversation, you spoke about gilt funds. So, is it time to review and reduce exposure to them at this point? How should one approach this?

Sandip Raichura: If you have a higher-than-50–60% allocation towards gilt funds tactically, then the approach depends on your horizon.

There are two kinds of investors — someone with a five-year-plus horizon and someone with a three- to five-year horizon. For anyone with a shorter horizon, and by that I mean anywhere between two and five years, you should definitely consider underweighting gilt funds compared to your earlier allocation because most of the yield softening has already played out.

Remember, we had erratic monsoons in late August, so we don’t yet know what surprises on agriculture-linked inflation may come up, which could leave the RBI handicapped. In that situation, long-tenor gilt funds may carry certain risks in the near future, and therefore, I would definitely suggest some reduction in gilt fund allocation.

Kshitij Anand: In fact, the monsoon stretched into September in many parts of India, and that is something…

Sandip Raichura: Yes, we have had a bad situation in Punjab, for example. Agricultural belts have been severely impacted, and that could have some medium-term impact on inflation.

Kshitij Anand: That is something investors need to watch out for. On the same note, we talked about gilt funds, so should investors shift their focus towards credit risk funds or corporate bond funds in 2025 for better returns? What should the strategy be?

Sandip Raichura: Yes, credit risk funds fall at the other extreme of gilt funds in terms of credit risk. We have been overweight on credit risk right from the COVID period.

The underlying economic shift we have seen in policymaking and in how corporates approach their balance sheets has resulted in a dramatic amount of deleveraging. This means that when you take on credit risk, the probability of default is much lower. I think we are at the lowest historical point since then.

To that extent, you should definitely be invested in corporate bond funds. Now, whether you should look at credit risk would partly depend on your risk profile.

There is an enormous amount of liquidity available in what we call the mid-tier and lower-rated bonds, and these balance sheets are very healthy. I would suggest that if you had a ₹100 allocation towards non-gilt bonds, roughly 33–35% of that could and should go towards credit risk.

Let me also point out something I read recently — last month was historically the highest month of emerging market junk bond, or what we call high-yield bond, investments by foreigners. That flow is already visible internationally, and if it finds its way into India, we might see an additional kicker coming in from much lower-yield and previously stressed bonds at least.

Kshitij Anand: And when we talk about bonds and interest rates, for the benefit of investors, what are the key interest rate risks they should be aware of when investing in debt instruments today?

Sandip Raichura: From a risk point of view, inflation is the key macro factor, and to that extent, what happens to G-Secs is primary. We have seen about a 20 bps move in G-Sec yields.

We were at 6.26% a couple of months ago, and we are currently around 6.5%. So, what happens to G-Sec yields is of primary importance.

In terms of credit spreads, meaning the spread between AAA-rated or AA-rated paper and G-Secs, we are at roughly 80–90 bps, which is an equilibrium. So, inflation and therefore G-Sec yields will be the primary drivers of risk for bond investors.

Kshitij Anand: And what fixed-income allocation strategies would you recommend for institutional investors like corporates or trusts?

Sandip Raichura: These are very differentiated entities. From a trust’s point of view, I think G-Secs should form a large component because you do not want too much volatility.

Therefore, about 70–75% of that money should be in G-Secs and relatively risk-free instruments. About 10–15% should definitely be allocated to dynamic bond funds, which give leeway to the fund manager to decide how to deploy the money, and about 10% to high-yield bond funds, which come in various shapes and sizes. These could be as simple as a corporate bond fund or as complex as a credit risk fund.

From an institutional point of view, the primary objective for an insurance company, for example, would be long-term investments.

There are enough 10-year-plus tenor funds available, and therefore, we would recommend longer-tenor G-Sec funds, including target maturity plans, along with a large allocation to corporate bond funds. I do not think credit risk funds should form a significant part of their portfolio, except perhaps for a small allocation.

Otherwise, the focus should remain on these two categories. They should, of course, avoid shorter-term instruments.

(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)