<b>Your Money:</b> Move into shorter-duration debt funds

As the rate cut cycle over for now, investors bet largely on funds for duration not exceed 3-4 yrs

With the Reserve Bank of India (RBI) choosing not to cut the policy rate in its monetary policy review, and more significantly, moving from an accommodative to a neutral stance, it appears that the current policy rate cut cycle, which started in January 2015, is over for now. Debt fund investors should move the bulk of their investments into short- and medium-term funds and to dynamic bond funds if they have not done so already, say market experts.

According to debt fund managers, RBI did not cut policy interest rates because its focus has now shifted to ensuring macro-economic stability. “RBI is now intent on achieving 4 per cent CPI (consumer price index) inflation on a durable basis, hence it couldn’t have cut rates,” says Suyash Choudhary, head, fixed income, IDFC Asset Management.

Adds Bekxy Kuriakose, head, fixed Income, Principal Pnb Asset Management: “While in the previous policy review there was concern about sticky core inflation and global uncertainty, this time concern has been expressed about rising fuel and base metal prices as well as dollar strength, which can feed into imported inflation.”

For most experts, the element of surprise in the monetary policy lay in the shift in stance from accommodative to neutral. "In practical terms, this shift means that after a sizable rate cut cycle the RBI is now signalling a long pause. The next move, whenever it happens, will be data-dependent. It could be in either direction and may not necessarily be a cut," says Choudhary. Kuriakose does not expect any further policy rate cuts in this calendar year. Further, the cuts will depend on the trajectory of oil and commodity prices (should soften) and rate hikes in the US (should pause).

Investors need to shift the bulk of their debt-fund investments into short- and medium-term funds with a modified duration of three-four years. They may also invest in dynamic bond funds, which are actively managed. This means that the fund manager should have a track record of changing his strategy with the shifting market dynamics. Investors who have been using a long-duration strategy may need to exit gilt and income funds.

Investors with a low risk profile should invest 75 per cent of their debt portfolio in short-term funds (modified duration up to three years) and medium-term funds (modified duration of three-five years) having conservative credit quality (almost 100 per cent in triple-A paper). The rest of their debt fund portfolio may go into lower-risk fixed-maturity plans (FMPs). These investors should avoid investing in credit opportunity funds even though their returns may be more attractive. 

Investors with a moderate risk profile may invest 25 per cent of their portfolio in dynamic bond funds and credit opportunity funds (with a moderate risk profile), and the remaining 75 per cent in medium-term and short-term debt funds. Aggressive investors may invest 33 per cent in dynamic and credit opportunity funds, and the balance in short-term and medium-term funds.

Investors who need to exit longer-duration funds should stagger the process so as to get good prices. There is no need to panic as interest rates are unlikely to move up immediately (the upward move of the 10-year G-Sec after the policy meet was a kneejerk reaction to the fact that a cut had been priced in). Also, with interest rates having moved down, investors need to pay heed to expense ratios of debt funds and avoid paying too much.