Duration or accrual: Where should debt investors park money now?
Mint, Sahil Kapoor, head-products and market strategist at DSP Mutual Fund, said duration strategies look appealing right now because of wide spreads between the 10-year G-sec yield and the repo rate.So, what exactly is a duration strategy? And what other strategies work in the bond market? Here’s a closer look.Duration funds take a directional call on interest rates. If the fund manager expects rates to fall, he increases exposure to longer-dated bonds.The logic rests on a basic bond market rule: yields and bond prices move in opposite directions.
When interest rates rise, yields go up and bond prices fall. When rates fall, yields decline and bond prices rise.So, if interest rates are expected to fall, fund managers may take higher duration calls—meaning they increase allocation to longer-maturity bonds—because these bonds are likely to see price appreciation, boosting returns.Longer-maturity bonds are more sensitive to changes in yields.
A 10-year bond will experience a far sharper price swing for a given yield change than a 2-year bond.This makes duration funds—particularly gilt funds, which invest in government securities (G-secs) and state development loans (SDLs)—well suited for this strategy. G-secs carry minimal credit risk since they are government-backed, but they do carry significant interest rate risk, especially at the longer end of the curve.The accrual strategy takes a different approach.
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