Tuesday, March 07, 2023

Why Investing in Government bond funds is recommended, especially now? Data backed with example from the past.

I missed the data shared at end of the article when I was with friends, to back why I am confident to recommend to invest in government bond funds currently.

The Background-

                                                                  Above photo Creator: Javier Sanchez Mingorance Credit: 123RF

We were a group of friends and it so happened that somehow we came to discussing which bank is giving high interest rates and why it is good to lock in FDs now for long term- as interest rates are currently near top and very less room of rising higher and then it should stabalise and start going down after some time. I suggested to invest in long term government bond funds and this opened a pandora's box and a superb discussion full of arguments.

Guess what, this discussion went on for 35 to 40 minutes. Here's what was covered.

To question me someone quickly googled and shared this to the group-

"Fds are currently offering better and higher interest rates than they were about a year back. In early 2022 the 1 year Fixed Deposit rate was about 5.35% and currently SBI is offering 1 year deposit rate @7.3% roughly. So in one year there is about 2% higher fixed deposit rate offered. Why should I not invest in FDs?"

Quickly another friend went to one of the most used and popular Mutual Fund comparison site and shared the below-

He said, "compare this FD rates with 10 year government bond mutual fund Investment return and average category return is just about 4% in last 1 year- my friend was laughing just about savings bank rate? and you are saying to invest in government bond funds? Even in last 3 years the average returns have been 5.2% pa"

Do you still say to invest in government bond fund offered by a mutual fund?

"Yes, I said. Imagine you locked your 1 year FD @7.3% and next month RBI increases rates by another 0.50 basis points or %. Naturally the new FD rates will rise to 7.75% roughly. Now imagine if this FDs are tradable in market. What will you do?"

"I will sell my 7.3% FD and buy 7.75% FD"- said another friend.

"And, what if now after 3 months RBI reduces the rate by 0.5%? What will have higher demand, 7.3% FD or 7.75% FD?"

"Naturally, 7.75% FD"- immediately came the reply.

"That is where the demand for 7.75% keep increasing at every rate reduction and hence the price of the same FD keeps increasing for some time. This is where interest keeps coming for same 7.75% to the buyer and capital gain happens because of price increase of that FD due to higher demand in reducing interest rate cycle"- I explained.

Now you tell me what do you think, how much interest rates can up more? What do you think can RBI increase interest rates more?, if yes, how much?

And that is where my friends said we understood this but we need data to get convinced on what you are saying.

AND that is where I started this article by saying "I missed the data I am sharing at end of this article, or else, friends would have walked out with full confidence and clarity"

So here's the back data, friends.

Here we have picked up data from 2018, January and tracked this until 31-12-2020 to see similar situation what happens and why I remain so convinced and confident.

Below is just 2 year yield curve of 10 year government bond starting 1st January 2018 until 1st January 2020.

It is apparently clear that the yield curve is clearly downward. (Similar to our example of FD rates reducing for simplicity)

Now look at below reference table for more clarity.

                 (Above image is research data by CFP CM Viresh Patel, Financial North and any reproduction or reuse of the image or data is strictly prohibited)

The above reference table is divided in 2 parts.

EXTREME RIGHT TABLE- Rate cycle for 3 years starting 1-1-2018 until 31-12-2020. If you see that table, the yield as on 1-1-2018 was around 7.43 (Accidently that is exactly where current 10 year G sec yield is) and by end of 2020 the yield had fell to 5.89%.

NOW, LOOK at LEFT SIDE TABLE- At the same time period, i.e. starting 1-1-2018 the NAV of SBI MAGNUM GILT Fund was 38.0079 and by the end of sample period i.e. 31-12-2020 the NAV rise to 50.4745 and the 3 year average returns on the same fund was about 10% pa. (look at the % changes in NAV Column every year period.The change in 2018 was 5.07%, in 2019 was stunning 13.36% and in 2020 was 11.43%).

This is exactly what I said when I explained with the example of FD @7.75% and it's increased demand in reducing rate cycle.

Also, please be mindful that while my friend extracted data of past 1 year returns from GILT / long term government bond funds, he was comparing it with current FD rates.

Where do you think we are currently?

How much can RBI increase more?

What will RBI do in it's next RBI Monetary policy- Increase rate, take a pause or reduce rate?

Is there chance of rate increase more or you see rate reducing coming?

Do you also now concur with my call on investing in Government Bond or G-sec or GILT Funds, offered by mutual funds? Do you agree ?

What do you need more, my friend/s?

Do Comment.

This is for private circulation only.

Any details or data or image usage in part or full from this article needs to be with prior permission of the blogger of this original article by CFP CM Viresh Patel, Founder Financial North.

Clarity and Disclaimer-

A- This is not a Investment advisory for all and may or may not suit the general reader, and that is the reason it is only for private circulation only and no further claims on basis of this article will be entertained and in no way guarantee any returns and neither it needs to be concluded that returns in past will or can be replicated.

B- SBI Magnum GILT Fund is take here for example and within Debt category there are min.16 categories and more than 40 AMCs and it may or may not suit you.It is taken only for example and representation purpose and that it in no way should be understood as a recommendation, nor any tip etc.

PS- Indian Government bond yields as on 10-3-23, (various periods)

Very Recent Example to Understand this better from US Government Bonds and Treasury Yield very recent changes- 13-3-23

PIMCO Extended Duration Fund - 5 Day change - 5.37% up

Vanguard Longterm Treasury Fund - 1 day 3.14% up

US Bond Yields today as on 13-3-23

    US Bond Yields as on 9-3-23         

So Just in 5 days, the yields went down a lot and that  is where the longterm Bond Funds gave 3% in one day and 5% in 5 days returns, which was negative 24% in last year.- Vanguard fund, as the interest rates went up very high and in short period.

India Government Bond Yield Changes and it's effect on SBI Magnum GILT FUND- (1 month comparision)

SBI Magnum GILT Fund 1 month Changes as on 20-3-23 (Last NAV 17-3-23)

10 Year Government Bond Yield changes in 1 month (as on 20-3-23)

Update - 6-4-23 on the day RBI decided to take a pause on repo rate changes-

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