India Bond Investors Capitalize on Rising Swap Rates to Enhance Returns

Higher Swap Rates Drive Indian Debt Fund Managers into Synthetic Fixed-Rate Trades

Multi-year high swap rates are driving some Indian debt fund managers into trades aimed at boosting fixed-income returns. Aditya Birla Sun Life Asset Management Co. and DSP Asset Managers Pvt. are among those buying floating-rate corporate bonds and using overnight index swaps to turn them into synthetic fixed-rate investments to lock in higher interest rates.

Swap rates have gained since the US-Iran war began in late February, as traders bet that an oil-driven inflation surge will lead to tighter monetary policy, with the three-year OIS touching its highest level since 2023 last week. Markets have priced in 125 basis points of rate hikes over the next year, according to MUFG Bank Ltd., whose base case is only for 50 basis points of increases.

Investors are earning 75 to 100 basis points more than regular bond yields by entering into swap agreements with floating-rate corporate bonds. This is how the trade works: Investors buy floating-rate bonds, which typically pay interest linked to a three-month Treasury bill rate plus a credit spread. They then use an overnight index swap to exchange the floating payments for fixed ones.

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There has been a surge in floating-rate bond issuances as expectations of higher global interest rates make fixed-rate debt less attractive. Investors are instead moving toward securities whose coupons reset periodically with market rates.

At least five issuers have sold floating-rate notes since mid-May, raising 64 billion rupees ($667 million). Two more issuers — Cholamandalam Investment and Finance Co. and Muthoot Finance Ltd. — are due to seek bids for as much as 100 billion rupees on Monday. Cholamandalam alone plans to raise 50 billion rupees, potentially making it the largest floating-rate bond sale ever by a local lender.

From the issuer standpoint, they are getting volumes in what is otherwise a challenging market, said Suyash Choudhary, chief investment officer for debt at Bandhan AMC Ltd. Lenders like Cholamandalam and Muthoot typically earn floating-rate income from loans and assets, so issuing floating-rate liabilities helps better match their balance sheets, according to Shantanu Godambe, a fund manager at DSP Asset.

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Most floating-rate bonds issued by shadow lenders in recent weeks have been three-year notes, matching the maturity segment where swap rates have risen the most.