India’s long bonds have become a crowded trade, Edelweiss warns

An Indian bond fund manager has cautioned that the recent surge in India's 30-year bonds may be excessive, driven by expectations of policy rate cuts and increased foreign fund investments.

Dhawal Dalal, overseeing 820 billion rupees ($10 billion) in assets as head of fixed income at Edelweiss Asset Management Ltd., highlighted concerns about the crowded nature of the trade. Investors, aiming to capitalize on anticipated shifts in India's interest rates, heavily favor 30-year bonds, Dalal noted in an interview in Mumbai.

"We anticipate no significant long-term decline in India's bond yields," stated Dalal, drawing on his 27 years of market experience. He emphasized that India has yet to achieve the low inflation levels typical of developed economies, where inflation stabilizes between 2% and 3%.

The recent inclusion of Indian bonds in JPMorgan Chase & Co.'s index has amplified global investor interest, prompting diverse strategies among local funds seeking an advantage. Despite competitors like Bandhan Asset Management heavily overweighting long bonds, up to 90% of total assets in some cases, Dalal advocated caution, citing potential volatility stemming from thinner liquidity.

The spread between 30-year sovereign debt and 10-year bonds has narrowed considerably, from 100 basis points in 2020 to about five basis points recently, marking the tightest level since March 2023.

While Dalal's firm retains approximately 25% of assets in 30-year bonds, he emphasized the perceived value in more liquid 10 to 15-year debt, with around 40% of assets allocated to 10-year bonds.

Dalal predicted that the Reserve Bank of India may embark on a limited rate-cutting cycle this fiscal year, potentially reducing yields on 10-year bonds by 25 basis points. However, he cautioned against assuming whether this would result in a parallel decline across the yield curve or a widening spread between 10 and 30-year bonds.

The Reserve Bank of India has maintained a policy rate of 6.5% for over a year to manage inflation, which, while easing in recent months, remains above the central bank's 4% target at 4.75%.

Despite increased foreign investor holdings in Indian sovereign bonds following JPMorgan's index inclusion announcement in September, Dalal expressed uncertainty about their long-term commitment. He likened their investment behavior to equity markets, where profits are taken and reinvested based on perceived valuations and market opportunities.

Edelweiss Government Securities Fund, managing 1.48 billion rupees in assets, has performed strongly, achieving a 5.64% return in the last six months, according to ValueResearch’s fund rankings.

"In light of these factors, prudence is needed before heavily committing to a portfolio of 30-year Indian government bonds," Dalal cautioned.

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