Forgettable quarter

The huge amount of wealth destruction that occurred during the last quarter is amply illustrated by the fact that liquid funds have been the best performers among all investment categories in the latest Crisil study of mutual funds.

Crisil's liquid fund benchmark delivered annualised point-to-point returns of 4.28 per cent for the quarter, while the benchmark for diversified equity funds gave negative returns of a massive 36.54 per cent.

The income fund benchmark also gave negative returns of 5.5 per cent, and the unfortunately named monthly income plans too offered a negative return of 12.70 per cent, while gilt funds gave a negative return of 8.30 per cent. The return from balanced funds was much worse, at a negative 24.22 per cent.

Investors would have been far better off keeping their money in bank fixed deposits, so it is easy to understand why small savings schemes continue to be so popular.

It would be unfair, of course, to compare the performance of the mutual funds with bank fixed deposits solely on the basis of their returns in one quarter.

That is so not only because of the well-known fact that stocks outperform other asset categories over the longer term, but also because the June quarter was an exceptional period.

This was the time of maximum political uncertainty, when the change of government led to a stampede for the exits in the stock market. Add to that the rise in interest rates in the US and the flight of portfolio capital back to the developed markets, and stocks were certainly not a preferred asset class in the first quarter.

It was also a period when inflation rose almost week to week, as a result of which the bond market reversed direction. Since long-term securities lose the most when interest rates rise, it made sense for investors to stick to short-term instruments.

That is why liquid funds performed better than all other mutual fund categories in the first quarter. To be fair to mutual funds, one should also remember that several equity funds had delivered returns well in excess of 100 per cent last fiscal, and were also able to comfortably beat the Sensex.

Going forward, the indices show that the stock market bottomed out during the June quarter, and the returns from equity funds this quarter should therefore be better.

The finance minister's decision to abolish long-term capital gains tax and lower the short-term capital gains tax has led to a rally in the mid-cap stocks, which should help some of the less risk-averse funds post good gains.

But while the stock market has stood up remarkably well in the face of rising inflation, record oil prices and rising interest rates, the bond markets have been in turmoil.

The spike in bond yields in the last few days, if sustained, will mean that among the debt funds it's the liquid funds that are likely to outperform once again.

On the other hand, with GDP growth continuing to be fairly robust at least till the next harvest, the outlook for equity funds does not appear quite so bleak in the short term, in spite of concerns about FII inflows.