Corporate bonds meet arbitrage: a smarter, tax-efficient play for fixed income investors

Time of India

4 days ago

In a rapidly evolving fixed income landscape, investors are increasingly seeking strategies that deliver not just stability but also tax efficiency.
One such approach gaining attention is the blend of corporate bond exposure with arbitrage opportunities — a smart way to generate steady returns while optimizing post-tax outcomes. Gautam Kaul, Senior Fund Manager – Fixed Income at Bandhan AMC, believes this hybrid strategy can offer the best of both worlds: predictable income from high-quality corporate debt and low-volatility gains from arbitrage.
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In this exclusive conversation with ETMarkets, Kaul shares why this product mix is particularly suited for today's macro environment, how retail participation is evolving, and what investors should watch as India enters a new rate cycle. Edited Excerpts –
Kshitij Anand: Let me ask you, how does combining corporate bonds and arbitrage strategies help in creating a stable return profile for investors?
Gautam Kaul:
I believe you're referring to the new category where there is a fund of funds that feeds into arbitrage or non-directional equity, as well as fixed income.
The idea is to provide a stable return profile. For example, in our case, the Bandhan Income Arbitrage Plus feeds into the Bandhan Corporate Bond Fund (approximately 60%) and the arbitrage fund (around 40%).
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What investors get is non-directional equity exposure and corporate bond exposure. In our case, the strategy is to manage the bond maturity between one to four years.
The cherry on top, of course, is the tax advantage—after two years, it qualifies for long-term capital gains (LTCG). So, it's a much more efficient way of allocating to fixed income.
One challenge we found many investors were facing was that, while they wanted to allocate to fixed income, the tax change introduced in March 2023 made them hesitant due to the imposition of short-term capital gains even on long-term investments.
This fund not only provides a stable return profile but also offers a much better post-tax experience for investors.
Kshitij Anand: In fact, can you also explain what the Bandhan Income Plus Arbitrage Fund of Funds is, and how it differs from traditional debt or arbitrage funds?
Gautam Kaul:
The Bandhan Income Plus is a fund of funds. For those unfamiliar with the concept, a fund of funds is a fund that, in turn, invests in other funds. So, you get a combination of different funds in a single package.
In our case, the strategy is to allocate 35–40% of the inflows to the arbitrage fund, and the rest to the Bandhan Corporate Bond Fund. As mentioned earlier, the objective is to create a stable return profile through non-directional equity exposure.
We believe that, for most debt investors, the majority of their investments should ideally be in the one- to five-year maturity bucket, forming the core of their long-term asset allocation.
This fund of funds, combining arbitrage and corporate bond strategies, provides that exposure in a more tax-efficient manner.
Our Corporate Bond Fund is PRC(A) rated, meaning the average rating of the portfolio must be maintained at AAA at all times.
The goal of the corporate bond fund itself is to maintain a very high-quality, liquid portfolio that offers a stable investment experience.
And because it's a corporate bond fund, the idea is that most of the time, investors will earn a spread over the sovereign yield curve.
Kshitij Anand: Let me also get your perspective on interest rate movements. We have already seen a 50 basis point cut by the RBI, and the central bank is expected to possibly cut further over the next 12 months. How are funds like yours positioned to benefit from or be impacted by a falling interest rate environment?
Gautam Kaul:
What I find is that long-duration fixed income often tends to be a tactical play for investors. With equity, you can invest for the long term, but bond investments tend to be more tactical — if the RBI is cutting rates, investors get in, and then exit once the benefit is realized.
However, one must look beyond just the rate cuts. While rate cuts are obviously important and a major contributor to mark-to-market gains for investors, there is more to the story.
Right now, the market seems fairly divided — will the RBI need to cut further, and if so, when? That's one part of the narrative.
The other part is about looking at relative valuations and identifying segments of the yield curve that offer value, even in the absence of a rate cut.
So, when you think of fixed income, consider it as a part of long-term asset allocation. Within that framework, portfolio managers like us try to exploit whatever value exists at various points on the curve.
As things stand today, given that both growth and inflation are somewhat undershooting expectations, there's probably a case for rate cuts.
More importantly, the Reserve Bank is already providing liquidity — first through OMOs and then via the CRR cut, which takes effect from September.
This should lead to reasonable demand for both high-quality
corporate bonds
and government securities.
From a portfolio construction perspective, depending on your appetite for duration, you could consider five- to seven-year G-Secs or corporate bonds.
For those with a longer investment horizon and greater appetite for volatility, we believe long-term government securities offer significant value.
A 30-year G-Sec, for instance, offers immense potential — not just as a tactical mark-to-market play, but as a long-term investment where you can lock in an attractive annualised return over three decades from a Government of India credit.
Kshitij Anand: Let me also get your perspective on the retail investor side. Retail investors seem very bullish on equities, with SIP flows exceeding ₹27,000 crore. But are they also showing interest in short-term corporate bonds, or is demand largely institutional?
Gautam Kaul:
I think the industry has done a great job not only in promoting mutual funds but also in reinforcing the concept of asset allocation. Many concepts in finance that may seem boring — like asset allocation — are actually what work best over the long term.
Retail investors are beginning to appreciate that a long-term equity journey and the compounding it enables are more important than trying to make large, one-off allocations.
Proper asset allocation ensures your compounding journey doesn't get disrupted at the wrong time. Also, fixed income acts as a stabiliser in portfolios, and that need is being increasingly recognised.
There was some hesitation earlier, particularly due to the post-tax experience not being favourable. But with the introduction of new products, we're seeing traction from both retail and institutional investors. In absolute numbers, institutional investors stand out due to the large ticket sizes they bring.
But in terms of the number of investors, we're seeing strong interest across categories — from short-term corporate bond funds to gilt, dynamic, and long-duration fund categories.
Both retail and HNI investors have been coming in larger numbers over the past six to twelve months.