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Short Term Debt Funds

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Short term debt funds



The increase in the repo rate and cut in the marginal standing facility (MSF) by the Reserve Bank of India ( RBI) on September 20 will impact your debt mutual fund portfolio. The impact on liquid and ultra short- term funds might be limited or even positive. For short- term funds it could be partly positive, as yields will come down abit from their elevated levels. Longterm and gilt funds will be the worst hit by the rate rise.

The RBI governor has signalled that inflation is the most important thing. We could see a couple of more repo rate hikes. Standard Chartered Global Research expects a further 50- basis point increase in the repo rate by the third quarter. This means there is a possibility of bond yields going up. Hence, it makes more sense for investors to stay at the shorter end of the yield curve. Most investment experts ask investors to be cautious while investing in longterm debt funds.

Short- term interest rates could remain elevated over the next few weeks, although lower than the levels seen in August and early September. Ten- year government securities (Gsecs) could remain in the 8.1- 8.6 per cent band for the next few weeks.

Investment experts say if your investment horizon is a year you should look at capturing the potential fall in yields, as the yield curve is inverted. Therefore, they advise short- term debt funds that invest in bonds maturing in two to five years. Similarly, those having a longer horizon —one- and- a- half to two years — should look at long- term debt funds, as many believe inflation could come off in six to eight months and so will the repo rate.

We are recommending one- to five- year duration bonds because the MSF has been reduced, with further calibrated reduction expected. That will translate into higher accrual income and some capital gains in this segment, with the liquidity easing and the yield curve normalising. From a longer- term perspective, the 10- year G- sec is not very appealing for additional exposure, given the uncertainty around further direction in the repo rate and higher bond supplies in the next four- five months.

The rise in the repo rate resulted in a sharp up- move in yields of 10- year gilts. This could result in long- term gilt funds giving up the 2- 2.5 per cent gain they witnessed in the last four trading days. However, rates in the short- end, money market instruments could ease, given the lowering of MSF to 9.5 per cent. This could result in a price rally in short- term debt funds.

Even if the tilt is towards inflation coming down, it might not go below RBI's comfort level in the next six months. That could take up to March 2014. If aggressive OMOs ( purchases by RBI) are announced, risks to the 10- year G- sec could be higher. In such a case, the yields on Gsecs could go up, which could mean further capital loss on your long- term bond portfolio. It is better to invest money in liquid funds, which will ensure liquidity in the portfolio. This money can be later deployed in income funds if the situation improves. Says Prateek Pant, directorproducts and services at RBS Private Banking, We are not advising fixed maturity plans (FMPs) at this point." Investing in FMPs would mean forgoing liquidity. Existing investors of long- term bond funds should remain invested for the next one year; you could get a good exit opportunity after that.

According to Dhruva Chatterji, senior investment consultant (India) at Morningstar Investment Management, it still makes sense for new investors to continue to be at the shorter end until things stabilise a bit, because there will be some pressure on the longer- end yields. RBI's move to increase the repo rate is an anticipatory move to tackle the expectation that inflation will rise. So, gilt funds and long- term bond funds will be the worst hit. In any case, these long- term funds are for one to three years' duration and if you have invested in these in AprilJune, you should stay invested, because selling now will mean significant capital loss. You will have to pay exit load, too.

And, if investing now, keep horizon of at least nine- 12 months. Pant advises taking exposure (up to 10 per cent) in some international funds — Chinese or US, preferably — as a longterm strategic holding.

Happy Investing!!

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