With the Indian equity markets showing few signs of resilience in the midst of a global turmoil, investors are searching for other avenues to park their money. While debt is an obvious choice when equity markets are in doldrums, the signals are mixed on that front too.
For investors in debt mutual funds, these are difficult times as returns are adversely impacted if rates go up. And if the indications coming from the central bank and market experts are anything to go by, then the near future seems to offer limited options.
The Reserve Bank of India (RBI) has increased rates at regular intervals in the last year or so. With RBI's hawkish statement focusing on inflation control, yields may remain under pressure, says broking firm Sharekhan.
The debt fund family can be categorised into ultra short-term funds (debt and money market instruments with maturity ranging from 90 days to one year), short-term bond funds (maturity between one and two years), medium-term debt funds (bonds, debentures, government securities, money market instruments with longer maturity) and gilt funds (government securities)
Ultra short term funds, among others, performed well in July and experts are of the view that investors could use these funds to generate some returns in the immediate future. Thereafter, depending on the call on the interest rate movement, one can make a switch to the short-term or medium-term schemes.
According to data compiled by BS Research Bureau, short-term debt schemes have given a return of nearly eight per cent while ultra short term have registered average returns of 7.7 per cent in the one-year period ending August 2011. Equity funds, on an average, have lost nearly 14 per cent in the same period.
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Sandesh Kirkire of Kotak Mutual Fund says that a rising interest rate regime provides good opportunity for debt funds. "If the interest rates are high, the portfolio returns, the ability to generate returns is very high," he says. "It is actually contrary to the perception that debt funds are to be looked at only when interest rates start coming down," he adds. Kirkire does not agree with the concept that debt funds are a prudent bet only when rates are expected to fall.
According to a recent study by Crisil, majority of long-term debt funds outperformed their benchmark across all three time frames (one, three and five year periods). The outperformance of debt funds was largely a factor of active duration calls in a volatile interest rate environment, said the report.
"Ultra short-term debt funds and short-term debt funds provide a relatively better risk-return trade-off as there is low expectation of yields moving up significantly from current higher levels while we may see it moderating once liquidity improves," said ICICIDirect in a recent note to its clients. Longer duration yields are expected to be volatile taking cues from news flows from both the domestic and global front. Therefore, they are more risky compared to the shorter duration yield curve, it added.
Interestingly, there is a section of market players that feel that interest rates could start falling after a couple of months, as there are signals that inflation could stabilise at levels acceptable to the policy makers though it would still be above the comfortable zone. The reasons they cite is a probable fall in the prices of essential commodities. While crude, which accounts for a large part of India's inflation, has been moving up, But things may improve if the Libya crisis is resolved soon.
There is also a view that if one is ready to stay invested for a couple of years, then dynamic funds could be looked at. These funds are actively-managed debt funds wherein fund managers buy and sell securities when yields are going up or coming down.