Indian mutual funds to keep buying state bonds, expect yields to fall

MUMBAI: Indian mutual funds are likely to continue swapping the central government debt on their books with high-yielding state government bonds, expecting the spread in yields between the two to ease soon, four fund managers said on Thursday.

“Mutual funds likely sold 10-year government bond and got into state debt, as yield spread of around 40 basis points is still decent,” said Avnish Jain, head of fixed income at Canara Robeco Asset Management.

Jain expects mutual funds to continue with this switch in the next quarter amid expectations that state bond yields will slip when compared with central bonds.

Mutual funds have net sold central government bonds worth 143 billion rupees ($1.72 billion) over the last seven sessions, including a record single-session sale of more than 60 billion rupees on Monday, data showed.

The sale has coincided with record debt auctions from states, which raised an aggregate of 1.29 trillion rupees via three debt auctions.

“The recent interest in SDL (state development loans) auctions was largely due to higher-than-notified state debt supply in the last two weeks, which led to the widening of spreads vis-a-vis central government bonds,” said Anurag Mittal, fixed income head at UTI AMC.

States sold 10-year bonds at 7.43%-7.47% yield on Tuesday, while the benchmark bond yield is around 7.04%, with the spread at around 40 basis points.

Devang Shah, co-head of fixed income at Axis Mutual Fund, finds the absolute yield level of around 7.50% on state bonds to be an attractive entry point. The fund house has launched a dedicated state debt fund and increased allocation to state bonds in active funds.

Shah expects fiscal consolidation and lower interest rates over the next 12 to 18 months to aid the decline in yields, as well as compression in yield spread with government bonds.