Stable Indian government bond yields push investors towards more attractive corporate debt

Indian mutual funds and insurance companies are shifting towards an accrual strategy to capitalise on higher corporate bond yields, as government bond yields are expected to remain largely stable, investors told Reuters on Wednesday.

An accrual strategy focuses on earning returns primarily through interest payments, rather than through trading or capital gains. Fund managers are increasingly favouring shorter-duration bonds when yields are near the upper end of the range.

The LSEG benchmark AAA-rated two-year (INAAAPSU2Y=IMMU) and three-year corporate bond yields (INAAAPSU3Y=IMMU) stood at 6.56% and 6.70%, respectively, on Monday.

The spread between corporate and government bond yields in these two tenors has risen around 20-30 basis points over the past month to 85 bps.

"As long as there is no danger of policy reversing, the two-three-year bonds will respond to local liquidity... so, we have already reallocated funds from the long bonds to the 2–3-year corporate bonds," said Sandeep Bagla, CEO at Trust Mutual Fund, which manages overall assets worth around 35 billion rupees ($408.00 million).

The uptick in corporate bond yields has surpassed gains in government bonds since the Reserve Bank of India shifted its monetary policy stance and began withdrawing liquidity from the banking system.

"In the context of present market conditions and macro-economic environment, we are cutting duration ... I am positive on the shorter end as liquidity is likely to flow there," said Killol Pandya, head of fixed income at JM Financial Asset Management, which manages debt assets worth about 38 billion rupees.

"We have scaled back duration in our dynamic bond fund too," he said, noting that the company had gone from an exclusively government bond approach to strategically moving some funds to corporate bonds, towards the accrual system.

While mutual funds are concentrating on the shorter end of the corporate bond yield curve, insurance companies are showing interest in longer-duration bonds.

"We believe currently the most attractive part of the market is corporate bonds, especially the five-year to 10-year part of the curve," said Rahul Bhuskute, CIO at Bharti AXA Life Insurance.

The spread between five-year (INAAAPSU5Y=IMMU) and 10-year (INAAAPSU10Y=IMMU) corporate bond yields and government bond yields remains in the range of 75-85 bps.

($1 = 85.7850 Indian rupees)