Market Strategy: How to structure a fixed income portfolio in a changing interest rate environment?

Indian government bond yields traded higher on Monday, driven by a rise in US Treasury yields, with the benchmark 10-year yield hovering around 6.7367%. Investors’ attention has now turned to the Federal Reserve’s upcoming monetary policy decision later this week.

Supported by favorable demand-supply dynamics, controlled inflation levels and stable macroeconomic indicators, the domestic yield curve has exhibited a downward shift from October 2023. However, a combination of global and domestic factors over the past two months have brought interim volatility, pushing yields higher.

Over the last year, despite intermittent fluctuations, yields on long-term government securities (G-Secs) have declined by 40-50 basis points (bps). According to Motilal Oswal Private Wealth, long-term yields are expected to remain volatile, influenced by adverse growth and inflation data, global macroeconomic trends and ongoing geopolitical tensions.

On the global front, US Federal Reserve According to the CME FedWatch tool, interest rates have decreased by 75 bps since September and market expectations for an additional 25 bps rate cut this week have exceeded 97%. However, the chances of a rate cut in January remain at a modest 17%.

Domestically, the Reserve Bank of India (reserve Bank of India) has cut the repo rate and maintained it Cash Reserve Ratio (CRR) The December monetary policy indicated the possibility of a rate cut in February 2024.

In light of these emerging interest rate dynamics, here’s how investors can structure their fixed income portfolios effectively:

fixed income portfolio strategy

Motilal Oswal Private Wealth recommends maintaining an overweight position on accrual strategies while remaining neutral on term strategies in the current fixed income market environment.

term strategies

With respect to duration, Motilal Oswal says a significant portion of the yield reduction in 10-year G-Secs has already taken place, with yields falling from 7.35% in October 2023 to around 6.75% in December 2024. The remaining scope for further easing is limited and may be accompanied by interim volatility. Investors can take advantage of this last phase through long-term maturity G-Sec bonds or funds.

It recommends allocating 15%-20% of the portfolio to actively managed duration funds or long-term G-Sec papers/funds (average maturity of 15-30 years).

accumulation strategies

Accumulation strategies can be leveraged across the credit spectrum, with allocations meant to deliver stable returns. Motilal Oswal suggests the following division:

– 40%-50% of the portfolio should be focused on performance credit and private credit strategies including InvITs and select non-convertible debentures (NCDs).

25%-35% can be allocated to performance credit strategies, InvITs and NCDs.

>15%-20% can be invested in private debt, including real estate/infrastructure strategies and select NCDs.

– 15%-20% of the portfolio can be allocated to short term instruments such as:

> Arbitrage funds (minimum holding period of 3 months),

> Floating rate funds (holding period of 9-12 months), and

> Full Return Long/Short Strategies (minimum holding period of 12-15 months).

– Tax-efficient fixed income option

To optimize tax efficiency, the report recommends allocating 20%-25% of the portfolio to conservative equity savings funds with a minimum holding period of 3 years.

This portfolio strategy is consistent with the evolving interest rate environment and seeks to balance return potential with risk reduction.

Disclaimer: The views and recommendations given above are those of individual analysts or broking companies and not of Mint. We recommend investors to check with certified experts before taking any investment decision.