Debt fund NAVs fall as FIIs withdraw funds

Last month's carnage in the debt market has hit domestic bond-fund returns. Debt mutual funds saw their net asset values (NAVs) fall the last month as prices of their bond holdings dipped in the recent rout. Foreign institutional investors (FIIs), which bought Indian debt paper worth Rs 22,000 crore in the first five months of 2013, were net sellers of Rs 32,336 crore in June. Until last month, bond funds were sitting on high annual returns of more than 14 per cent, as RBI had cut domestic interest rates by 75 basis points and bond prices gained. Led by the FII selling, bond prices have fallen, resulting in higher yields. Thus, the monthly returns of debt funds are negative at 1-2 per cent.

Long-term gilt funds dipped by 1.77 per cent last month, according to Value Research, while debt income funds dipped by 1.22 per cent. Short-term debt funds also fell, by around one per cent. On an annualised basis, this loss works out much higher.

Funds that invest in debt which matures over the longer term have been hit the most than funds that invest in short-term debt. Over last month, fund managers have been adding more longer term debt to their portfolio, one big reasons for the fall in their fund NAVs. Says Dhruva Chatterji, senior investment consultant, Morningstar India: "Many funds had increased the average tenure of their bond holdings last month anticipating a fall in interest rates. Gilt funds took a bigger hit and some short-term bond funds also took a hit, which is quite unusual."

Yields on bonds increased in last month while bond prices dipped. The 10-year G-sec yield increased to 7.46 per cent, from 7.11 a month ago (see chart).

Liquid and ultra-short-term bond funds, however, bucked the trend, with their NAVs rising nearly 70 basis points last month as they benefited from the rising yields. These funds have been unaffected by the fall as they invest in very short-term debt instruments.

Investors who entered long-term debt funds recently, anticipating a further rate cut by the Reserve Bank of India, were caught unawares by the US Fed's announcement that it would taper quantitative easing. This saw a massive exodus of funds from debt markets all over the world. Foreign investors sold debt of Rs 32,336 crore in June.

This, however, may be a temporary trend, given that the overall trajectory of domestic inflation is still trending downward and, hence, the interest rates are also expected to move lower. Bond fund managers are taking advantage of the rise in yields and are shifting gears. Some are even adding more to their portfolios as yields have risen. Says R Sivakumar, head fixed income group, Axis Mutual Fund: "We have been adding to our bond folio duration in the past few days as yields have improved."

Analysts expect bond yields to come off in the next few months as the rupee stabilises and might expected to fall from current levels, but analysts aren't expecting investors to make double-digit gains this year as they had made last year. Says Chatterji: "Last year, yields came off significantly but I don't expect these to fall much from here. Bond funds will not make substantial gains like last year. Investors could look at short-term debt and dynamic bond funds now."