Funds bullish on debt as rates decline

Domestic fund managers are positive about the prospects of the debt market in 2008 as they anticipate Indian interest rates to soften next year.

They foresee rates declining by at least 25 basis points in July to December as economic growth begins to moderate, due to the Reserve Bank of India's monetary tightening steps since 2005. Debt fund managers also expect yield on 10-year gilts to drop up to 50 basis points next year.

Mutual funds see short-term close-ended debt schemes, especially fixed term plans, attracting inflows even in 2008, while debt fund managers advise investors to consider investing in long-term funds too.

Majority of fund managers are of the view that long-term debt schemes will make a comeback in 2008, after being in hibernation since 2004.

However, a few also believe investors would prefer hybrid schemes initially, and then gradually move to long-term debt funds.

Rate views
Sameer Kulkarni, debt fund manager, Fidelity Mutual said, "If the government manages to keep inflation within the 5 per cent limit prescribed by Reserve Bank of India (RBI) despite rising (global crude) oil prices, and prices of food articles, a rate cut could be on cards some time in 2008."

RBI aims to keep inflation under 5 per cent in the current financial year, and 4-4.5 per cent in the medium-term.

For the week to December 8, Wholesale Price Index (WPI) inflation was 3.65 per cent.

A Balasubramanian, chief investment officer, Birla Sun Life Mutual expects the central bank to cut repo rate by 25 basis points next year as the first step in keeping interest rates neutral-to-soft.

Sundaram BNP Paribas Mutual Fund also expects a 25-basis-point repo rate cut by Reserve Bank of India in April due to interest rate differential with US, and likely domestic economic slowdown, said Prasad Nalam, chief investment officer.

"We are almost at peak interest rate. (Interest rate) differential between the US and India has widened. Our interest rate should go down from here. The first signal for that was that many banks cut their deposit rates," Nalam said.

In the last three months, the world's largest economy has cut its key interest rate by 100 basis points in total to 4.25 per cent currently to ward off a credit market crisis.

On Indian rates, Nalam said, "Housing, consumer finance numbers are weak. RBI would think of cutting the repo rate "" which is the key signalling rate "" by 25 bps."

The central bank has raised repo rate, now at 7.75 per cent, seven times by 25 basis points each since October 2005

Since September 2004, RBI has hiked cash reserve ratio by a total of 300 bps to 7.5 per cent currently.

Anticipating a rate cut in the second half of 2008, Devendra Nevgi, chief executive and chief investment officer of Quantum Mutual said, "We believe that there will be a slowdown in the economic growth. GDP growth rate in 2008 is likely to be around 8 per cent."

RBI has pegged GDP growth at 8.5 per cent for the current financial year. Sandeep Bagla, chief investment officer-fixed income, AIG Mutual expects a 50-basis-point rate cut in line with easing global interest rates, and due to slackening liquidity.

He said, "If RBI keeps inflation in control, I see interest rate falling towards 2008 end."

Long-term funds
On the possible comeback of long-term debt schemes, Balasubramanian said, "There is a clear shift that investors should make in terms of taking interest rate calls, and should invest in a mix of long-term gilt and income funds."

In 2004, returns of debt schemes fell as bond yields rose due to domestic interest rate hikes, resulting in huge outflows.

Nevgi of Quantum Mutual said, "I think long-term schemes should be in vogue in the next 2-6 months. In my opinion, it is a good time to invest in a long-term debt or a gilt fund."

However, Nalam does not expect long-term debt schemes to be popular in 2008.

He said, "Equity funds would give more returns. From long-term debt schemes, people can expect a return of 10-11 per cent. Equity would give more than that."

Sanjay Sinha, chief investment officer, SBI Mutual, agreed with Nalam, saying, "Eventually yes, but not immediately because the very heady returns of equity (funds) have raised expectations."

Sinha predicted, "We will probably see interest coming more to the hybrid funds first, and then gradually extend to long-term debt funds."

Returns
On expected returns from debt funds, Balasubramanian said, "The probability of double digit return from (long-term gilt and income funds) is very high."

For the year to December 20, long-term gilt and medium-term debt schemes recorded 5.47 per cent and 6.65 per cent average returns, respectively, while liquid funds registered an average return of 7.49 per cent.

Bagla sees 10-12 per cent annualised returns from long-term schemes, while short-term funds might yield 9-10 per cent.

10-year gilts
SBI Mutual's Sinha expects yield on 10-year government bond to touch 7.25 per cent by the end of 2008, while Bagla of AIG Mutual anticipates 7.5 per cent yield. Nalam said, "I do not expect more than 50 bps (fall in yield of 10-year gilt) unless US interest rates drop to 1 per cent, which is unlikely." The 10-year benchmark 7.99 per cent, 2017 paper was today quoting at 7.8564 yield.