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Should you invest in bond funds in 2018?

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Investors may be averse to investing in bond funds in 2018 after a choppy 2017 gave poor returns. During the calendar year, the 10-year benchmark yield climbed 88 basis points from 6.4% to end at 7.28%, reducing the returns from all categories of debt funds in a volatile year.

Value Research data for the calendar year 2017 show the dynamic bond fund category gave an average return of a mere 3.27%, while the Gilt (Medium and Long term) category returned 2.08%, reflecting the volatility in broader interest rates. The last three months were among the worst, with investors losing 0.41% and 1.79% in dynamic bond and Gilt (medium and long term) categories, respectively.

With concerns over rising oil prices, increasing fiscal deficit and lower GST collections, fund managers believe that bond yields are headed upward.

“The bond market is going to be volatile with yields going up,” said Lakshmi Iyer, chief investment officer-debt at Kotak Mutual Funds. “If oil prices trend upward, we may even see rates increase toward the end of 2018. Investors incurring MTM (mark-to-market) losses in the last one year need to look at bond fund returns from the long-term perspective of about three years.”

Given the likely hardening of rates, fund managers have taken corrective action and reduced the duration in their fund portfolios in the second half of the year.

“We have more than halved our average maturity to about five-six years now,” said Kumaresh Ramakrishnan, head of fixed income, DHFL Pramerica MF. “Bond yields may harden further given the expected slippage in fiscal deficit. It makes sense to invest in shorter maturity schemes amid uncertainty over interest rates.”

Given these concerns, wealth managers believe in taking a conservative approach to investing in debt funds.

“We are in an upward rate cycle and the benchmark 10 year could trade between 7.5-7.7% during the first half of the year,” says Rupesh Bhansali, Head (Distribution), GEPL Capital. He advised investors to invest only in liquid and ultra-short-term funds and stay away from duration and dynamic bond funds.

Value Research data show that the Liquid category has returned 6.37% in the past one year, while ultra-short-term funds have returned 6.40%.

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