Inflation may haunt long duration funds; experts warn of impact on MFs

Such schemes are more sensitive to interest-rate scenario that can change due to high inflation

The sharp spike in inflation can come to haunt long duration funds, with mutual fund experts cautioning that it can weigh on returns delivered by such schemes.

“If inflation remains sticky, the room for rates moving down dramatically will reduce. This means holding a long duration fund will not make much sense from a risk-reward perspective,” said Kaustubh Belapurkar, director (fund research) at Morningstar Investment.

On Monday, the data released by the National Statistical Office showed that retail inflation had risen to a five and a half year high of 7.35 per cent for December 2019.

Also, longer duration funds can see sharper hits on returns if interest rates or yields go up in response to rising inflation.

“If either interest rates or bond yields jump somewhat, long duration funds will get impacted more since interest rate sensitivity is higher,” added Belapurkar.  

On Tuesday, the yields on 10-year government bonds inched higher by 7 basis points (bps).

Fund managers say bond yields can further go up in calendar year 2020 (CY20). “Eventually, high inflation, proximity to terminal repo rate, improving growth conditions, and fiscal stress will mean even government bond yields will move higher in CY20,” said Maneesh Dangi, chief investment officer-fixed income, Aditya Birla Sun Life Asset Management Company.  

Further, fund managers say inflation can also seep into other components of the consumption basket, beyond food.

“Right now, inflation is being driven by food prices. Eventually, we can see it start to move into various pockets of the consumer basket,” added Dangi, at an event on Market Outlook 2020 on Tuesday.

In a one-year period, long duration funds have been among the top performer debt funds, with returns of 12.44 per cent. The series of successive rate cuts introduced by the Reserve Bank of India (RBI) have led to a strong performance delivered by these funds.

The RBI has cut repo rate by 135 bps in CY19 to a nine-year low of 5.15 per cent.

Meanwhile, shorter duration funds are likely to be better placed if the RBI decides to reverse these rate cuts to contain rising inflationary pressures.

“A consistently high inflation can lead to interest rates creeping up, and it can get factored into shorter duration funds. In products like short duration and low duration funds, you start getting higher yields or returns on the product, which act as a natural hedge,” said Vidya Bala, co-founder at PrimeInvestor.

“Also, funds with investments in two-three year tenure corporate papers can be a good opportunity in the current scenario,” said Dangi.

In a one-year period, the ultra-short duration funds have given returns of 6.84 per cent, while short duration and low duration funds have given returns of 4.8 per cent and 2.29 per cent, respectively.