[graaja]

Originally Posted by carboy

Take a bond of face value Rs. 100. Let's say the interest rate is 5%. Each year it pays the holder Rs. 5 & then at the end of 5 years, it pays 105 (final years interest plus + principal).

Originally Posted by anandhsub

Value of bonds and the interest accumulation assuming you mean growth funds and not dividend funds.

In technical terms the interest accumulation is called the "carry" of the bond.

Thank you for the explanation. Bonds (and bond MF) have started to make sense now.

[carboy]

Originally Posted by graaja

Thank you for the explanation.

With stocks, we aim to buy undervalued stocks. Does the same apply with bonds as well? For an example, below are two bonds.

Stock market in India has a lot of retail participation. But the bond market is mostly bought & sold in the secondary market by institutional players - atleast it was so when I checked it some years back. Other than that, calculating the current tradable value of a bond is a far, far more deterministic calculation as compared to calculating the value of a stock - i.e if 10 different people calculate the instrinsic value of a stock, all of them are going to arrive at different answers. OTOH, if 10 people calculate the value of a bond whose issuer's financial strength hasn't changed - all 10 will arrive at an identical value - upto even places after the decimal point. Only thing which changes is the predication of whether the company is going to be solvent enough to repay or not. Owing to lesser variability in this & lack of retail participation, our bond market seems to be super efficient. Very rarely do you find overpriced bonds or bonds at a discount. If some bond looks cheap, its probably because the strength of the company issuing the bond has gone down & the certainty of paying back the bond may not be as sure as it was before. Considering this, debt funds are the best way for the retailer to invest in bonds.

[SmartCat]

Originally Posted by graaja

With stocks, we aim to buy undervalued stocks. Does the same apply with bonds as well? The first one is overvalued and the 2nd is undervalued. Were I to invest in one of these which one would be the logical choice?

Depends on who you are. If you are a professional bond trader working for a bank/MF/insurance company, you would want to buy an undervalued bond and book profits in an overvalued bond.

But if you are just an investor, it is unlikely you will trade bonds based on fair value. You will just buy and hold till maturity if you are satisfied with yield to maturity. That's because the alpha generated by trading bonds is unlikely to significantly affect your overall (debt + equity) portfolio returns.

So between the 2 bonds, there is not much to choose from because yield to maturity is similar.

Note: Above discussion is leaving aside aspects like credit quality/liquidity risk etc.

[graaja]

Originally Posted by SmartCat

But if you are just an investor, it is unlikely you will trade bonds based on fair value. You will just buy and hold till maturity if you are satisfied with yield to maturity. That's because the alpha generated by trading bonds is unlikely to significantly affect your overall (debt + equity) portfolio returns.

So between the 2 bonds, there is not much to choose from because yield to maturity is similar.

Thank you. It is perfectly clear now.

Originally Posted by SmartCat

Note: Above discussion is leaving aside aspects like credit quality/liquidity risk etc.

Absolutely. All other risks being considered, I wanted to understand how much an undervalued/overvalued bond would affect returns for an investor who would stay invested till maturity.

[adimicra]

Thanks for your responses.

Between gilt funds and gilt funds with constant 10 year duration, what makes more sense. I was looking at the below fund from ICICI with constant maturity - the expense ratio is 0.23% while yield-to-maturity is 6.70%

Looks good to me, thoughts?

[SmartCat]

Originally Posted by adimicra

Between gilt funds and gilt funds with constant 10 year duration, what makes more sense. I was looking at the below fund from ICICI with constant maturity - the expense ratio is 0.23% while yield-to-maturity is 6.70%

Regular gilt funds can invest up to 50% of assets in 90 to 180 day treasury bills and upto 100% of assets in 10 year bonds. But constant maturity gilt funds have to compulsorily invest 100% of assets in 10 year govt securities.

PROS of constant maturity gilt funds (Cons of regular gilt funds):

- Lower expense ratio than regular gilt funds, because fund manager does not have much to do. Research team will be tiny.
- Have historically generated higher returns than regular gilt funds.
- Returns not dependent on fund manager skills. He does not need to predict interest rates
- When interest rates go down, NAVs will shoot up rapidly (compared to regular gilt funds)

CONS of constant maturity gilt funds (Pros of regular gilt funds):

- When interest rates go up, NAVs will drop rapidly when compared to regular gilt funds.
- Skilled fund managers of regular gilt funds who have a knack of predicting interest rates can theoretically generate high quartile returns with low volatility by shifting 50% of assets to short term treasury bills when interest rates are rising, and shifting 100% of assets to long term bonds when interest rates are falling.

[adimicra]

^^

Thanks for the explanation, it is super helpful.
Given the current scenario, for a 5+ years time horizon - constant maturity debt fund might be a better bet I think - would like to know your thoughts.

[eyesice]

To Fellow gurus -
Now that RBI has hiked the repo rate, can we expect a higher YTM for liquid funds (and in general other funds)? I am especially looking to park a lumpsum amount in Liquid funds for upto 4 years v/s FD to gain taxation benefits.

[vj_torqueaddict]

Originally Posted by adimicra

^^

Thanks for the explanation, it is super helpful.
Given the current scenario, for a 5+ years time horizon - constant maturity debt fund might be a better bet I think - would like to know your thoughts.

I am no expert , I have learnt everything from members here, especially smartcat.

Currently we are at the low end of interest rate cycle. It will increase and it has today. If the investment horizon is 5 years then avoid constant maturity GILT. Go for Regular, because GILT Nav falls in increasing interest rate regime. If you want the money say after 11 years , go for constant maturity. Look at the YTM and avg maturity age of the underlying bonds. It should give you some hint.

P.S- I am in invested in both constant maturity and regular. Depends on your investment horizon.

[thanixravindran]

Originally Posted by SmartCat

invest in RBI floating rate bond. There is a lock-in period of 7 years.

All major banks offer RBI floating rate bonds for investment. If you have a SBI account, just google "RBI floating rate bond SBI"

Hi SmartCat - I am looking at this RBI floating rate savings bond (FRSB) investment for 5 to 10 years horizon. Is the 7 year only savings bond scheme available from RBI or anything available for a slightly less duration of 5 years? I understand the interest is paid out each 6 months and so guess it is simple interest rather than getting compounded like a long term FD. Due to the absence of compounding and floating interest rate of these bonds, will both returns be same at end of 7 years if we assume current interest rate (7.15 Vs 5.7) holds good for simplicity?

Is there any other better avenues for lumpsum investment now like a fixed rate bond available? Or simply shall I wait till the next rate hike and go with FD once it reaches 6 percent? I cannot take advantage of senior citizen schemes.

[carboy]

Originally Posted by thanixravindran

Due to the absence of compounding and floating interest rate of these bonds, will both returns be same at end of 7 years if we assume current interest rate (7.15 Vs 5.7) holds good for simplicity?

You can always compound it yourself. As soon as the interest gets credited, buy a new bond (or any other debt instrument) with the interest.

[etrast75]

FWIW, for those looking for long term bonds with stable interest rate, take a look at rbi retail direct site.. You can buy CD and Sovereign bonds at rates better than what banks are offering now and it is probably the safest form of investment. I have been investing quite a bit there and I year CD is currently at around 6 %.

[SmartCat]

Originally Posted by thanixravindran

Is there any other better avenues for lumpsum investment now like a fixed rate bond available? Or simply shall I wait till the next rate hike and go with FD once it reaches 6 percent? I cannot take advantage of senior citizen schemes.

Originally Posted by etrast75

FWIW, for those looking for long term bonds with stable interest rate, take a look at rbi retail direct site.. You can buy CD and Sovereign bonds at rates better than what banks are offering now and it is probably the safest form of investment. I have been investing quite a bit there and I year CD is currently at around 6 %.

You can use Zerodha to buy GoI bonds/treasury bills/state development loan (SDLs) bonds too:
https://coin.zerodha.com/gsec

[DigitalOne]

I was just checking out recent Debt funds' performance given the high inflation, raising interest rate scenario and was very surprised to see the last 1 month returns of Gilt funds.

Gilt funds have given a return around 1 - 1.2% in the last 1 month. My conventional thinking was Gilt funds will give a negative return in a rising interest rate scenario, but this is clearly not happening now. Is there a short-term opportunity to get a 10-11% return in 1 year from Gilt funds?

The last 1-month returns are higher in the Target maturity funds (Example 1, 2 ). Another opportunity?

Are there some risks that I am not seeing?

Also what happens to target maturity funds in their year of maturity? Do they just close the fund and money returned to investors (like a FMP)?

[SmartCat]

Originally Posted by DigitalOne

Gilt funds have given a return around 1 - 1.2% in the last 1 month. My conventional thinking was Gilt funds will give a negative return in a rising interest rate scenario, but this is clearly not happening now.

Conventional wisdom is that when a company makes profits, the stock goes up and when a company declares losses, the stock goes down. But that does not happen all the time right? That's because many times, profit/loss of company is anticipated by investors/analysts and hence it will be in the price.

Similarly, when it comes to bonds, there will not be perfect 100% correlation (in the short term) between increase/decrease in rates and price movement of bonds. Because, just like stocks, in the short term, everything will be in the price of the bond already (based on anticipation of investors)

Translation:

Gilt fund NAVs fell 3% from the peak, which was probably an overreaction caused by fear of runaway inflation. Since RBI has not given aggressive statements on interest rate outlook, there is probably a 1% rise in NAVs now.

Is there a short-term opportunity to get a 10-11% return in 1 year from Gilt funds?

Unlikely. But can happen if:

- Russia-Ukraine war stops.
- Wheat exports resume (thereby cooling world food prices)
- Crude price crashes
- US goes into recession, causing all commodity prices to crash
- Indian inflation cools down because of the above

The last 1-month returns are higher in the Target maturity funds (Example 1, 2 ). Another opportunity?

Constant maturity funds will fall more and go up more. That is, it has higher volatility when compared to regular gilt funds.

Also what happens to target maturity funds in their year of maturity? Do they just close the fund and money returned to investors (like a FMP)?

No. The fund manager will buy government bonds of higher maturity. For example: if a fund has 3 bonds maturing in 2023/2024/2025, after one year, he will have bonds maturing in 2024/2025/2026.