Investors foreseen turning to liquid funds and floaters

CRISIL RANKING OF MUTUAL FUNDS

Fund managers expect investors to prefer liquid funds and floaters over gilt funds going forward. This is because the hike in reverse repo rate effected by the Reserve Bank of India will lead to hardening of gilt yields, which in turn will impact income and gilt fund returns, they said.

The Reserve Bank of India announced a 25 basis point hike in its reverse repo rate to 5 per cent in its credit policy for 2005-06 (April-March).

Following the hike, fund managers expect the yield on the 10-year government bond to rise to 7.25-7.50 per cent over a one-month period.

In a rising yield scenario, debt funds such as income and gilt funds, which mainly invest in long-term bonds, are more susceptible to capital loss compared to liquid and floating rate funds, which are essentially income accrual products.

Fund managers feel that liquid and floating rate funds will be the preferred products in the debt funds category, going forward.

"As a result of the reverse repo rate hike, short-term (bond) yields as well as long-term yields will move upwards. Short-term funds are likely to give stable and positive returns as compared to long-term funds. More interest will be seen in liquid or short-term funds and floating rate funds, which offer more or less similar returns. Even fixed maturity plans (FMPs) will be in demand due to certainty of returns as compared to long-term debt products," said a senior fund official at a private mutual fund.

In April 2005, liquid funds and floaters gave average returns of 0.57 per cent. Medium-term debt funds gave average returns of 0.31 per cent. Short-term gilt funds registered 0.32 per cent average returns while medium-term gilt funds posted negative average returns of 0.36 per cent.

Mahendra Jajoo, head-fixed income at ABN Amro Mutual, said, "As it is there is not much money in income and gilt funds (for further redemption). I feel after this (reverse repo rate hike), liquid and floating rate funds will do better. Where else will people put money? The shift from debt funds to bank deposits due to attractive returns is also already happening. Equity market is also not performing well, hence redemption proceeds from equity funds will also flow into liquid and floating rate funds."

The category of income and gilt funds have been continuously witnessing massive redemption since May 2004 due to volatility in debt market on account of rising global crude oil prices, uncertainty over interest rates, rising domestic inflation. In 2004-05 (April-March), the industry witnessed erosion in assets of gilt and income funds due to fall in returns of these schemes.

The assets of gilt funds declined 24.05 per cent to Rs 4,576 crore, while the debt funds' assets fell 23.86 per cent to Rs 47,605 crore. The assets of liquid funds rose 29.65 per cent during the year to Rs 54,068 crore, representing 36.14 share in total industry assets.

Ganti Murthy, debt fund manager at SBI Mutual, said, "Investors may also park their money in bank deposits due to attractive returns compared to debt funds."

There is also a section of fund managers who feel that the current debt market condition is the right time for investors to invest in debt funds to benefit over a medium-to-long term. Murthy said, "When the yields are at 7.25 per cent levels, investors should now in fact think of investing in debt funds."

By the end of April 2005, the benchmark 7.38 per cent, 2015 government bond was trading at 7.2280 per cent yield-to-maturity.

Franklin Templeton Mutual in its monetary policy view said, "With the 10-year yields moving up sharply, accruals are attractive at these levels, given the liquidity. We expect interest from nationalised banks to increase going forward and at current levels medium-term funds offer a good entry point. Hence, investors should consider short-term income funds and gilt funds for investment and conservative investors could continue to stay invested in floating rate bonds."