Bond holders can play interest rate game !
It is not a good idea to react to every news we read and hear and login to brokerage website to do trading to take advantage of the news. Most of the time, we know the news is released only when the price has made its movements. It is a loser’s game.
But there are also certain trades/investments we can do with very high conviction and profit out of it.
Playing interest rate game is one of them.
While I strongly recommend the “Buy and Hold strategy” for long term investors in good performing mutual funds or ETF, I also advocate active management of bond funds with a view on interest rate movements.
Unlike gambling, this strategy has a very small downside but great potential for profit in the short term. Bond price movements are directly opposite to interest rate movements. For example, if you have a bond that pays 10% interest rate to the holder and if the market interest rate goes down from 10% to 9%, your bond is valued more and vice versa. This is a very simple theorem and any high school kid could understand it. This simple theorem can help us to make some money in the bond market. [ Sorry Bank Fixed deposit holder, you are not allowed in this game to make money, because Fixed deposits are not tradable in the market]. Only bond holders and bond fund holders can make use of this opportunity.
Since RBI showed some signs for interest rate reduction, RRK advisory has asked our clients to increase the duration of their bond holdings. Indian Bond funds can be classified as follows from lower duration to higher duration.
- Liquid / Money Market funds
- Ultra short term funds
- Short term funds
- Medium Term funds
- Long Term funds
We also have floating rate funds that have floating interest rates. The name of the funds may say short term or long term. Don’t bother too much about it. Floating rate fund ( short term) of one fund house may be longer than floating rate fund ( long term) of another fund house. But generally they fall in the area of liquid fund to Ultra short term fund region.
When interest rates go down, the value of the fund holding in these funds will go up. This will result in NAV increase, not so much from yield increase. NAV increase can help us to sell these funds for profit in 12-18 months time. FMP also can be used for this game. But FMP will end maturing at the wrong time or at the time when you don’t need the money. With open ended fund, we can call the shots and decide to take profits when the time is right.
Review your portfolio and look for funds you dont need for another 12-18 months, start moving them down the ladder (given in the list above). Every step down should give you about 0.5% to 1% NAV increase in one year. For those who are interested in learning more, google for Average Duration of Bonds and its impact on NAV.
If you are holding fixed deposits, think about exchanging them for open bond funds now. The premature closure penalty can be easily offset with this move. Further capital gains from bond funds are subjected to indexation benefit. So, bond holders holding the fund for more than a year, can enjoy higher after tax return.
Some Recommended bond funds for this strategy are:
PS: These bond funds have exit loads to discourage shorter holding time. Hence investors should check this factor before choosing one fund over other.
If you are our client, please give us a call, we will be happy to check your portfolio and advice appropriate moves in your debt portfolio.