Liquidity tightening measures announced by RBI led the 10-year government yield to rise by 53 basis points from 7.56 percent on 15 July to close at 8.09 percent on 16 July. Since interest rates and bond prices have an inverse relationship, the rising yields led to a fall in NAVs of debt funds.
As per Value Research, the sharpest decline was seen in long duration funds which fell by 2.59%. Long duration funds are more prone to interest rate changes. The short and ultra-short term funds were less impacted as compared to long term funds as they are less sensitive to interest rate changes. Thus, liquid (-0.18%) and ultra-short term (-0.47%) funds recorded smaller fall in their NAVs.
Market participants were earlier expecting that RBI will move towards softer interest rates. However, the falling rupee played spoilsport and led RBI to step in to tighten the money supply overnight. Fund managers are keeping a close eye on the movement of rupee. “The next few days would be quite volatile for the market as we get better clarity on the Rupee front… if the Rupee does not stabilize, one could see more measures from the RBI. Any further liquidity draining measures could leave impact across the yield curve,” said Lakshmi Iyer, Senior Vice President & Head (Fixed Income and Products), Kotak Mutual Fund.
The sudden rise in the yields has posed a good opportunity to lock in high yields.
“This was an unexpected event which affects market sentiments. The average returns on liquid funds were more than 10% (on an annualized basis) yesterday. So the situation reverses. It is a good time to invest in FMPs with a one to three year time horizon which can easily offer 10% return. Investors should not panic and redeem,” said Dheeraj Singh of Finanzlab Advisors.
Experts are advising people with less risk appetite to invest in short term and ultra-short term bond funds. In a report, Dhruva Raj Chatterji, Senior Investment Consultant, Morningstar advised “Investors with a higher risk appetite can also consider this extreme move as a buying opportunity, and take a duration call through the route of a dynamic bond fund or actively managed bond fund. However, investors who cannot digest volatility, and have a lower risk appetite, are better off with short-term and ultra-short bond funds at this juncture.”
Lakshmi advises investors to stick to their asset allocation. “First advice to investors is: do not panic. In fixed income, the chances of losing your capital are low, unless there is a credit default. Only the time taken to recover the capital goes up as the portfolio year to maturity (YTMs) rise because of higher interest rates. Hence investors should stick to asset allocation between long and short duration funds even at current times,” said Lakshmi.
Vinod Jain, Principal Advisor, Jain Investment is advising his clients to invest in banking debt funds. “We are cautious on bond funds and are looking for opportunities to enter. We will start advising our clients to invest in banking debt funds for a period of one year. We won’t take exposure to funds which invest in corporate papers since the liquidity is tightened and their working capital requirements will go up. We are also advising to go for arbitrage funds for investors who have investment horizon of less than one year. Interest rates will remain high for the next three to four months and will come down after that due to better monsoons and thus RBI will have room to ease the liquidity,” declared Vinod.
Though arbitrage funds invest in equities their returns are in line with liquid funds. Arbitrage funds take advantage of the pricing difference in cash or equity markets and futures market. As per Value Research, Arbitrage funds have delivered around 8% over a one period. Unlike debt funds where the fund pays a dividend distribution tax, arbitrage funds are technically equity funds and their returns are tax free. Debt funds on the other hand attract long term capital gains tax of 28.32%.
Mukesh Dedhia of Ghalla Bhansali Securities says that it is a good time to enter debt funds. “People who have invested for three to four years need not worry as the returns will get adjusted in the long run. Investors who had invested for 30 days would have seen their returns getting impacted. It is a good time to enter debt funds since yields are now attractive. Bank debt funds are also a good option since the papers come with good credit quality,” said Mukesh.
Vishal Dhawan of Plan Ahead Wealth Advisors is advising clients to hold on their investors. Vishal said “It is a good time to lock in yields either through funds which invest in bank papers or through FMPs which invest in bank CDs. We have made strategic allocation in both short term and long term funds. We are not advising investors to redeem. The dust will settle down soon.”
"Since yields have risen over the past couple of days, it would be more profitable for investors to switch to short term debt funds to capture the high yields available on thse short to medium term bonds," said Ganti Murthy, Head - Fixed Income, Peerless Mutual Fund.
