Time for some debt wish?

INVESTING

After a turbulent 2004 when rising interest rates ravaged debt schemes, the mutual fund industry is gearing up for a better story in 2005. We asked some fund managers whether this year would be a good one for the small investor to invest in debt mutual funds:

Sashi Krishnan, CEO at Chola Mutual Fund said many factors seem to be turning positive for debt funds. Inflation has eased considerably to below 6 per cent and thje global commodity cycle is past the inflection point. The rupee has also appreciated considerably, he said, and pointed out that liquidity in the banking system is considerably better now.

"Though there is some concern about US interest rates rising a little more rapidly, with US jobless claims data not being encouraging, the US Fed may just as well continue with its measured pace of rate hikes."

Nilesh Shah, CIO at Prudential ICICI Mutual Fund said, inflationary pressures pushed interest rates beyond expected ranges and resulted in very volatile returns to the investors last year.

"It is an academic point that most debt funds have outperformed the benchmark index by a reasonable margin. Clearly the drop in the assets under management of income funds has bared the verdict of the investors," he said.

Debt fund managers have aggresively advised clients to move into floating rate funds and hybrid funds since mid 2003.

Shah said his fund expects 2005 to be different in the sense that hopefully interest rates will not be as volatile as 2004. "This should help debt funds to deliver better returns," he said.

Rajiv Anand, head of investments, Standard Chartered Mutual Fund, believes that unlike equities, it is always a good time to invest in debt funds.

"This is because debt funds provide a host of options that address investors with different risk appetites," he said.

For instance, on one end of the spectrum, there are fixed maturity plans (FMPs) which have largely predictable returns for a given investment horizon. Also, there are pure accrual schemes such as cash and floating rate funds, which are also designed for the risk-averse investor.

At the other end are active duration-managed schemes which endeavour to make trading gains through interest rate movements, and long-term schemes which are more stable on duration.

"The area between the two ends is covered by short-term and medium-term schemes which take smaller duration calls. Clearly, therefore, given the plethora of options provided, debt funds are suited to all seasons," Anand says.

So, what would they advise the small investor to do?

Krishnan of Chola said with yields stabilising and the downside appearing limited, investors can look to re enter short-term bond funds or gilt funds.

"There does appear to be some price risk in medium-term bond funds. This is because corporate bond spreads, which are significantly lower than usual, could still increase from their current levels by about 50 basis points. Even if the gilt yield curve shifts downwards, it may take some time for the bond yield curve to shift downwards," he says.

He believse short-term rates may not be very volatile and hence short-term fund returns would be stable.

"Gilt funds that are able to trade on the yield curve could also be considered by investors. Once the bond spreads expand back to normal, investors can consider shifting back to medium term bond funds" he said.

Shah Prudential-ICICI said, "We will ask investors to put money "" as much as their liquidity permits, that is "" into small savings instruments, which give a higher rate of return. We recommend investors to invest in liquid, floating and short-term funds from the capital protection point of view and teomparary parking point of view," he said.

Shah also suggests a look at hybrid funds such as monthly income plans and its variants, apart from balanced funds to generate higher returns.

"Those who would like to invest in medium to long term debt funds alone can look to gradually invest in long-term income funds at above 7 per cent yields on a 10-year gilt with a one-year investment horizon," he added.

Standard Chartered's Anand said while FMPs and accrual schemes can be looked at, measured exposure can also be taken in active duration-managed schemes in order to capture gains from market moments.