By ravi Kumar Singh and Saurabh Jain Managing reinvestment risks during a period of declining bond yields is going to be a major problem for fixed-income investors as the bank OF INDIA' target='_blank' title='reserve bank of india-Latest Updates, Photos, Videos are a click away, CLICK NOW'>reserve bank of india (RBI) gets ready to begin a policy easing cycle. Despite maintaining the status quo on policy rates at its december policy review, the RBI showed that it was willing to lower rates in order to assist growth by reducing the cash reserve ratio by 50 basis points in order to improve liquidity and provide balanced forward guidance on inflation and growth. Bond yields may continue to drop as a result, increasing the risk of short-term fixed income investments. What makes short-term investments and cash the most susceptible? The bond yield curve 'flattens' when the RBI starts monetary tightening; short-term yields that are sensitive to policy rates rise more quickly and move in line with long-term yields. In addition to their reduced susceptibility to changes in interest rates, cash and cash-equivalents offer higher yields, making them a desirable investment option during this time. This is how your credit score may be impacted by your marriage. This is the opposite during rate-cut cycles, when the curve steepens as short-term rates fall more quickly than long-term yields. As a result, reinvesting fresh capital at lower future rates frequently causes the fixed-income portfolios' returns to decline. Bonds have historically performed reliably during the RBI's easing cycles. Average change in asset class performance and domestic bond yields (bps) around the RBI's first rate decrease since 2002
Source: Standard Chartered, Bloomberg. Analysis of the five previous rounds of RBI policy easing (2002, 2008, 2012, 2015, and 2019) What are the options for investors? Fixed income investors might concentrate on protecting their current income streams while controlling risks in the event of declining returns. The following methods can be used to accomplish this:
Transition to longer-term bonds: In the past, longer-term bonds have provided a "term premium" over cash and short-term bonds as an extra incentive for investors to assume longer-term risks, such as inflation uncertainty and delayed consumption. Longer-term bonds that lock in higher yields can reduce the risk of reinvesting at lower rates and provide more consistent income over time when the gap between short-term and long-term yields widens.
Furthermore, there is a chance for capital gains because longer-dated bonds, especially those issued by reputable businesses and the government, tend to increase in value when interest rates decline. Because of this, they are a desirable choice for income-focused investors who want to strike a balance between risk and return while short-term rates are dropping.
Getting through the storm: Astute methods for protecting money in erratic markets Employ the 'laddering' technique: The 'laddering' method involves investors buying bonds that mature at regular intervals to spread their bond investments. By doing this, investors can maintain exposure to a range of yields while structuring a consistent income stream that closely matches their cash flow needs and regular liquidity. By locking in higher rates on longer-maturity bonds early on and preserving the option to reinvest proceeds from maturing bonds into new ones, this strategy can mitigate the impact of lowering yields in a falling-rate environment.
Bond ladders offer a combination of short- and long-term bonds to income investors, lowering the risks related to market timing while generating a consistent income stream. Optimistic allocation to corporate bonds: AAA-rated companies (PSU, quasi-government, and private) offer attractive current returns on high-quality corporate bonds, with spreads over government bonds that are now higher than the long-term norms. During a rate-cut cycle, the rates on AAA-rated corporate bonds have historically declined more quickly than those on government bonds. corporate bonds are attractive because they lock in both absolute yields and relative performance, or the possibility of value growth when yields fall. Did you invest Rs 1 lakh in gold, real estate, loans, and stocks in january 2024? Analyse how your money has grown. Extend your plan to incorporate a variety of resources: Another strategy to deal with falling yields is to supplement strategies that seek returns from a dynamically managed mix of assets, including cash, bonds, stocks, and commodities. Avoid these four common myths about financial planning in 2025. Even though it might be difficult to completely protect fixed income portfolios from the effects of falling bond yields, putting in place a structured plan using the strategies mentioned above can help reduce performance drag and guarantee periodic liquidity to take advantage of any opportunities should rate cycles turn.
At Standard Chartered bank in India, ravi Kumar Singh serves as the Chief Investment Strategist, while Saurabh Jain is the Managing director and Head of Wealth Solutions.
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