Why fund managers have turned cautious on long duration funds

Subscribe to enjoy similar stories.Just a few weeks ago, the case for gilt funds, which hold government bonds with long tenures, seemed compelling.A sharp rise in government bond yields had made valuations attractive, market sentiment had turned very pessimistic, and several fund managers argued that much of the concern around elevated borrowing and supply pressures was already priced in.Government bond yields rose amid inflation fears stoked by the West Asia war. A rise in yield means a drop in prices, making gilt funds attractive.

The market sentiment further boosted the case for gilts, with many believing that most of the concerns around elevated borrowing and supply pressures were already priced in.Banks, flush with liquidity after the Reserve Bank of India's (RBI) open market operations, were expected to rebuild their statutory liquidity ratio (SLR) portfolios — providing a steady base of buying for government securities. SDL, or state development loan, spreads over benchmark government bonds had also widened sharply on the back of higher-than-expected state borrowings, hinting at a potential normalization trade there.

This prompted several fund managers to give a tactical call on expectations of bond yields normalizing. The West Asia war, now in its third month with no resolution in sight, has changed the calculus.

Brent crude has surged nearly 60% since the US and Israel launched attacks on Iran in late February, and a fresh flare-up in the Strait of Hormuz on 5 May pushed prices to around $114 per barrel. India's 10-year benchmark yield rose to 7.04% the same day, while the rupee fell to ₹95.31 against the dollar, near record lows.A 10% rise in crude oil prices is estimated to push the Consumer Price Index (CPI)