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With RBI signalling an imminent hike in interest rates, Debt funds are better bets

WITH the Reserve Bank of India (RBI) giving clear signals of a possible interest rate hike, investors willing to invest in fixed-income or debt funds will find themselves in a bit of a fix over the kind of schemes they can choose to offset the risk on their investments arising out of higher interest rates.

While in the extreme short term, it may not impact the equity market, a rising rate scenario may affect the equity market adversely over a period of time. So conservative investors from the equity market, too, may shift a part of their wealth from pure equity funds to debt funds only to return when the equity market corrects in order to maximise gains. Usually, investors with a low-risk appetite invest in debt funds, but often, they take returns from these investments as guaranteed, which is far from reality.

Many investors are unaware of the fact that these funds can also lead to erosion of assets due to interest rate risks associated with them.

With the wholesale price index expected to be in double digits in the first quarter of 2010-2011, inflationary pressure is mounting on interest rates. According to a Dun & Bradstreet report, the prime lending rate (PLR) is expected to increase to around 12.50-13.50 per cent by the end of financial year 2011 from an expected 11-12 per cent by the end of financial year 2010.

Lending rates are expected to surge as an after-effect of the anticipated monetary tightening steps taken by RBI to rein in inflationary pressure.

The yield on 10-year government securities is also expected to increase to 8.3 per cent by the end of financial year 2011 as high inflation and further increase in policy rates by RBI may dampen sentiments in the G-Sec market.

FC Invest spoke to fund managers and wealth planners to find out the right mix of debt funds at a time when interest rates are expected to go up.


Although experts remain divided on the issue of investing in long-term debt funds, there was almost a consensus on three categories of funds that they feel can give good returns to investors.

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