FUND FULCRUM
December 2011

With the prevailing uncertainty in equity markets and an indefinite postponement of hopes of any recovery, retail investors accessing stock markets through equity mutual fund schemes are wriggling out fast. Around 125,000 equity investors closed their folios in November 2011 — the second highest in the current financial year after July 2011, when equity folios had shrunk by 330,000. Since the beginning of the current financial year, the industry has lost 770,000 equity folios. The gross sales of equity schemes hit a 31-month low in November 2011. According to the Association of Mutual Funds in India, gross equity sales in November 2011 were Rs 3,183 crore, the lowest since April 2009. Earlier months fetched fund houses an average sale of between Rs 4,000 crore and Rs 5,000 crore. In April 2009, they had sold equity schemes amounting to Rs 1,836 crore. Marred with poor performance, redemption pressure and distributors’ unwillingness to push mutual fund products, fund houses are finding it increasingly difficult to attract investments in equity. Even systematic investment plans (SIPs), which were a saving grace, have started showing a decline on the back of terminations and cancellations. Since August 2011, equity funds continued to get positive net inflows but in November 2011, the initial signals of redemption pressure were visible, with a marginal net outflow of around Rs 50 crore. Interestingly, the drastic decline in equity sales is the highest since the capital market regulator abolished the entry load on equity schemes with effect from August 2009. Despite the load ban, equity sales in some months had crossed Rs 8,000 crore. Currently there are a little over 300 pure equity schemes available.

The mutual fund industry is beginning to bear the brunt of tight liquidity and market uncertainty. All schemes except liquid funds recorded net outflows to the tune of Rs. 2,088 crore, according to the latest AMFI data. The inflows in liquid funds have also fallen compared to last month. In October 2011, liquid funds witnessed net inflows of Rs. 32,745 crore while in November 2011 the net inflows stand at just Rs. 5,861 crore. The AUM of equity funds dropped 8% to Rs. 1.48 lakh crore in November 2011 from Rs. 1.61 lakh crore in October 2011. The industry’s AUM slipped 2% from Rs. 6.95 lakh crore in October 2011 to Rs. 6.81 lakh crore in November 2011.

Piquant Parade

Financial services group IDFC has sold 25% stake in its mutual fund business to French major Natixis Global Asset Management (NGAM) for an undisclosed amount. The new partnership would help IDFC AMC reach international investors interested to pump money into Indian equity markets. Besides, NGAM's presence in Asia, including Japan, Singapore, Taiwan, and China would also receive a boost though this agreement. IDFC AMC now has the ability to offer domestic investors access to international investment opportunities through NGAM investment products.

A few large overseas fund houses like Vanguard, Old Mutual etc. are vying for a strategic stake of anywhere between 26% and 49% in Axis Mutual Fund, promoted by India’s third largest private sector bank, Axis Bank. The foreign players' interest in the asset management firm displays a renewed appetite for the domestic mutual fund story that has been witnessing consolidation in recent times.

Bank of India announced the acquisition of a 51% stake in the mutual fund joint venture between telecom major Bharti Enterprises and Axa Investment Managers for an undisclosed amount. With the acquisition, Bharti Enterprises, which has about 25% stake in the fund house, will exit the asset management business.

Edelweiss Financial Services, a leading financial services firm in India, is in talks with global investors to be a partner in their mutual funds arm Edelweiss Asset Management that manages assets worth about Rs 447 crore.

To enhance investor convenience and ease of accessibility, Quantum Mutual Fund, India’s first and only direct-to-investor mutual fund has tied up with Yes Bank to use its drop box facility across Mumbai. Investors can now drop their subscription applications at any Yes Bank drop box having the Quantum Mutual Fund logo. These drop boxes are located at various locations across the city, including 37 locations at railway stations, 38 ATM sites and 5 airports. However, investors will have to follow a few steps like enclosing the application along with the cheques and supporting documents in a sealed envelope with ‘Quantum Mutual Fund’ written on it, before dropping the application into the drop box.

ICICI Prudential Asset Management Company Limited has partnered with Bloomberg UTV to present on mutual funds and investing with a twist through live plays titled ““Tarakki ke Tarikey – An Innovative Investor Mela. Tarraki ke Tarikey is a part of many such initiatives under the AMC’s investor awareness platform “Tarakki Ahead”. Cutting across conventional financial programmes, the play titled “Tarakki ke Tarikey” by the theatre group “Circus” endeavors to “entertain while educating” investors on mutual funds and breaking some common investment myths. Beginning from Rang Sharda auditorium in Bandra, Mumbai, theater artists would take to the roads across 5 cities entertaining the audience through their 11 appealing short stories related to investment myths.

It seems that the AMFI’s Mutual Fund Utility Platform will take a longer time to be operational. The three month deadline given by AMFI to develop the software is too short.

In what can be called as a trend-setter for the mutual fund industry, IDFC Mutual Fund has allowed investors to invest less than Rs.1 crore as well as redeem mutual funds in its IDFC Money Manager Fund (Treasury Plan). It plans to extend the same facility to other funds as well in the days to come. The investor does not need to sign a cheque every time he wishes to invest. Just one SMS can help him buy funds on the same day’s NAV, thanks to the electronic time stamping mechanism. What makes this initiative different from the already existing mobile buying facility is that investors do not need to own a GPRS or smart phone with internet connection. India has more than 72 crore mobile phone users and the potential seems huge. The facility is currently available for sole proprietors, resident individuals (including guardians on behalf of minor). The AMC has tied up with SBI, Standard Chartered, Kotak Mahindra, HSBC, Axis Bank, ING Vysya Bank, Citibank and plans to extend the facility to more banks going ahead.

The Securities and Exchange Board of India has appointed K V Kamath, chairman of an advisory committee for the regulator’s Investor Protection and Education Fund (IPEF). The committee will be responsible for advising SEBI on investor education and protection activities that may be undertaken directly by the SEBI board, or through any other agency, for utilisation of the SEBI Investor Protection and Education Fund.

Regulatory Rigmarole

The Securities and Exchange Board of India plans to make it more difficult for investment banks to influence the recommendations of analysts through strict new rules aimed at a clear separation of the two functions. There is an inherent conflict of interest in research activities unless it is done by a pure research firm which is not involved in other activities. There should be a Chinese wall between advisory and research; the moment the wall is broken one could influence the other.

The Securities and Exchange Board of India will soon make it mandatory for compliance officers of all market participants to take a certification programme. The programme will be conducted by the National Institute of Securities Markets (NISM). The SEBI move assumes significance in the light of the recent regulatory changes that have made compliance officers responsible for many activities. In one such action, Sebi made compliance officers responsible for unsubstantiated news or rumours related to a listed entity spread by an employee of a market intermediary.

The Securities and Exchange Board of India has directed market intermediaries not to outsource core business activities and compliance functions. The direction comes in the wake of instances wherein intermediaries resorted to outsourcing, to reduce costs and at times, for strategic reasons.

SEBI in its recent circular announced to simplify the Know Your Client (KYC) process to make investing a friendly affair among investors. It has issued guidelines for uniform KYC process for the investors who intend to open accounts with different intermediaries in the securities market. The new KYC procedure will do away with the duplication of KYC registering with different intermediaries. As of now, if an investor intends to open accounts with different intermediaries for the purpose of trading / investment in the securities market, he has to undergo the process of Know Your Client (KYC) again and again. Therefore, to avoid duplication of KYC process with every intermediary, a mechanism for centralization of the KYC records in the securities market has been developed by SEBI. Thus once the investor has undergone the KYC process, an intermediary shall perform the initial KYC of its clients and upload the details on the system of the KRA. If investor intends to open account with another intermediary, the concerned intermediary can verify and download the client’s details from the system of the KRA. For the proper implementation of the KYC process, SEBI has notified KYC Registration Agency (KRA) Regulations. The Regulations cover the registration of KRAs, functions and responsibilities of the KRAs and intermediaries, code of conduct, data security, etc. An applicant for KRA status must also have a net worth of Rs 25 crore and have expertise for technology and systems and safeguards for maintaining data privacy and preventing unauthorised sharing of data. Initial registration would be valid for a period of five years. KRAs would be eligible for applying for permanent registration three months before the expiry of the period of certificate of initial registration. SEBI has also made provisions for inspections of KRA regarding books of accounts, records, infrastructure, documents and procedures.

The April 1, 2012 deadline for implementation of the new DTC (Direct Taxes Code) may not come into force on time.

India's advertising regulator has upheld an allegation that promotional booklets published by Association of Mutual Funds in India were misleading investors about returns from mutual fund investments. An investor had complained against the advertisements to the Advertising Standards Council of India's consumer complaints council, claiming that the promotional campaigns wrongly assured 'better' returns on mutual fund investments.

It has been a tumultuous couple of years for India's mutual fund business. A host of regulatory changes, especially the abolition of entry loads has meant a rapid reinvention of the business. Independent Financial Advisors (IFAs), who have been grappling with regulatory changes over the last two years, are still betting more on mutual funds than other financial products. IFAs are coming together for the first time to form a body, which will lobby to protect their interests. The association, planned on similar lines as the domestic mutual fund industry body AMFI, will voice its views in matters related to rules governing financial product distribution and investment advisory business. The association will function as the voice of IFA community. It will also double up as a knowledge sharing platform for IFAs. The association will cater to about five lakh IFAs, who sell a gamut of financial products from insurance to bank deposits, bonds, postal savings schemes and mutual funds, across the country.

NFO NEST
December 2011

Drowning of the Equity Fund drought?

After several months of drought, new equity schemes are surfacing again from the stables of old fund houses. Last week, LIC Nomura and Canara Robeco filed offer documents for open-ended equity-oriented schemes with the Securities and Exchange Board of India. These are the first such scheme documents filed for pure-play equity schemes by experienced fund houses in more than a year. According to the SEBI website, the last such scheme document was filed 15 months ago, in September 2010, when IDFC Mutual Fund had filed for a small cap fund. SEBI began to discourage look-alike schemes towards the later half of 2009. Since then only new fund houses filed and got approvals for launching plain open-ended equity schemes. Older fund houses tried new product structures like gold funds, life stage funds, children funds, capital protection funds, etc. to make sure their new offer does not resemble existing ones.

Keeping out the experienced fund houses, which have well-oiled distribution machinery, has hit inflows coming into the industry significantly. According to figures by the Association of Mutual Funds in India, just eight equity schemes were launched in the first 10 months of 2011. They collected Rs 602 crore, at an average collection of Rs 60 crore a month. In four of these months, not even a single new equity scheme was launched. In comparison, 20 schemes were launched in the first 10 months of 2010 raising Rs 4,570 crore. Average collection was much higher at Rs 457 crore a month. To put things in perspective, in the first 10 months of this year, 565 closed ended debt schemes, most of which were fixed maturity plans, raised Rs 99,450 crore.

Sundaram CapitalProtection-oriented Fund(3years–series 7)

Opens: December 7, 2011
Closes: December 19, 2011

Sundaram Capital Protection Oriented Fund 3 Years (Series 7) is a closed ended debt fund with an investment objective to seek income and minimise risk of capital loss by investing in a portfolio of fixed income securities. The fund may invest a part of the assets in equity to seek capital appreciation. The fund's portfolio structure has been rated as AAA (so) by CRISIL, which indicates highest degree of certainty regarding payment of face value of the investment to unit holders. The scheme will allocate 80% to 100% of assets in fixed income securities including money market instruments with low to medium risk profile. It would further allocate up to 20% of assets in equity and equity related instruments with a high risk profile. Exposure to derivatives will be limited to 50% of the net assets. Benchmark Index for the scheme is CRISIL MIP Blended Index. Dwijendra Srivastava will manage the debt portion and the equity portion will be managed by Srividhya Rajesh.

DWS Interval Fund (Series 1)
Opens: December 7, 2011
Closes: December 19, 2011

Deutsche Mutual Fund has launched a new fund named as DWS Interval Fund – Series 1, a closed ended debt fund with an investment objective to generate income by investing in debt and money market instruments maturing on or before the beginning of the immediately following Specified Transaction period of the scheme. The scheme would invest 100% of assets in domestic debt instruments including government securities and money market instruments with low to medium risk profile. Benchmark index for the scheme is Crisil Liquid Fund Index. The fund manager for the scheme will be Kumaresh Ramakrishnan.

L & T Short Term Debt Fund
Opens: December 7, 2011
Closes: December 21, 2011

L & T Short Term Debt Fund is an open-ended fund with an investment objective to generate returns for investors with a short-term investment horizon by investing in fixed income securities of shorter term maturity. The portfolio could comprise of CDs, CPs, government securities, money market and other debt/ fixed income instruments having shorter-term maturity. The fund would allocate 65% to 100% of assets in debt and money market instruments with residual maturity up to 24 months with low risk profile. On the other side, it would allocate up to 35% of assets in debt instruments with residual maturity greater than 24 months and less than 60 months with low to medium risk profile. The scheme may invest in securitized debt up to 50% of the portfolio. The fund is an appropriate fixed income product for investors who can benefit in the short term from the possible change in interest rate scenario in the coming quarters. CRISIL Short Term Bond Fund Index is the benchmark index for the fund. The fund will be managed by Ms. Bekxy Kuriakose.

Axis Capital Protection-oriented Fund (Series 3)
Opens: December 9, 2011
Closes: December 23, 2011

Axis Capital Protection oriented Fund – Series 3 is a close-ended capital protection oriented fund with an investment objective to protect the capital by investing in a portfolio of debt and money market instruments that are maturing on or before the maturity of the fund. The fund also aims to provide capital appreciation through exposure to equity and equity related instruments. The fund will invest 80%-100% in debt and money market instruments including derivative instrument up to 75% of the net assets of the scheme. And 0%-20% in equity and equity related instruments. The fund is benchmarked against Crisil MIP Blended Index. The fund will be managed by Mr. R. Sivakumar and Mr. Sudhanshu Asthana.

IDBI Dynamic Bond Fund, Canara Robeco Multicap Fund, Morgan Stanley Gilt Fund, Quantum Multi Asset Fund, Baroda Pioneer Sensex Plus Fund, Union KBC Small and Midcap Fund, SBI Tax Advantage Fund Series II, and LIC Nomura Midcap Fund are expected to be launched in the coming months.

GEMGAZE
December 2011

The unexplored treasure

In India, it is still the institutional investors who mostly invest in fixed income mutual fund products. Retail investor participation in this asset class through mutual funds is negligible. This is counter-intuitive considering the vast amount of savings that the Indian investors have in bank fixed deposits. If one looks at the asset allocation pattern of Indian retail investors, it is evident that Indians are predominantly fixed income investors by nature and convention. This anomaly is clearly an opportunity for the mutual fund industry. In terms of diversity of product offerings, the industry has come a long way. Debt mutual fund products come with different permutations of liquidity (or tenors), credit quality and interest rate-related volatility to address various investment requirements based on an investor's investment objective, risk appetite, and time horizon. The product bouquet encompasses liquid and ultra short-term funds, which invest in money market securities; fixed maturity plans that invest in securities matching the scheme tenure so as to lock in the yield prevailing at that time; income and gilt funds; capital protection-oriented schemes; and a vast offering of hybrid products with different combinations of equity and debt. The industry needs to invest in increasing awareness among retail investors so that they can take advantage of a wide array of useful products.

In December 2011 GEMGAZE, I showcase the GEMs among the debt funds. Kotak Bond Regular Fund and BNP Paribas Flexi Debt Fund have made an unceremonious exit paving way for fresh blood both from the Birla lineage – Birla Government Securities Fund and Birla Floating Rate Fund.

ICICI Prudential Gilt Investment Fund Gem

ICICI Prudential Gilt Investment Fund, a pure debt fund that invests only in government securities, has an AUM of Rs. 221 crore. The average maturity of the fund is high at 6.99 years, the yield to maturity (YTM) is 8.8%, and the credit quality is high. The portfolio is concentrated with 6 holdings with 84% in Government of India securities and 16% of the portfolio in cash. The fund has returned 6.43% in the past one year as against the category average of 6.40%. In recent times, the RBI has undertaken a series of rate cuts to infuse liquidity into the system. The falling interest rates have translated into an appreciation in prices of long-term bonds and government securities alike. Expectedly, this fund has benefited. The returns since launch have been a laudable 10.6%. The expense ratio is 1.5%.

Canera Robeco Income Fund Gem

Canara Robeco Income Fund (CRI), a pure debt fund that mostly invests in securities with maturity of over a year, has an AUM of Rs. 119 crore. The average maturity of the fund has fallen drastically from 8.23 years to 1.74 years, the average YTM is 9.59%, and the credit quality is high with AAA rated papers. The fund maintains a well-diversified portfolio of 17 holdings with the top 5 holdings constituting 52.76% of the total portfolio. Debentures constitute 48% of the portfolio, Government of India securities 8%, Commercial Paper 23% and cash 20%. The fund has delivered superior performance over the last three- and five-year periods, despite slipping somewhat in performance lately. Over a three-year period, CRI registered a 13.5% return, against the category average of 6.5%. Last year income funds, in general, under performed the debt category when compared with short-term debt funds. The rise in yields over this period led to fall in prices for the longer-term securities, affecting their portfolios. However, the fund consistently beat its benchmark CRISIL Composite Bond Fund Index. The fund's one-year return stood at 7.7%, against the category average of 8.02%. The returns since launch have been 8.78%. The expense ratio is 2.2%.

Birla Sunlife Dynamic Bond Fund Gem

Gilt funds can deliver negative or low returns when interest rates rise. However, with the yields on the benchmark 10-year government security now poised at 8.9%, a three-year high, investments made now in long term gilts/bonds may face limited downside risk. The Birla Sun Life Dynamic Bond Fund appears a good play in the above scenario, due to three factors. One, the fund has the flexibility to actively lengthen or shorten the maturity of its portfolio to deal with interest-rate risk. The fund has increased the average maturity of its portfolio from 1.6 years in March to 4.3 years in its latest portfolio. The longer maturity may pay off as interest rates peak out over the next few months. Two, the fund has actively invested in a mix of corporate bonds and gilts to take advantage of the widening or narrowing of spreads between the two. In June 2011, corporate debentures took up 51% of assets while certificates of deposit made up 18%. In recent months, the fund has halved its exposure to certificates of deposit and added both cash and gilts. A 23.5% exposure to cash equivalents gives the fund, the ability to add gilts or even lengthen the maturity profile further, if interest rates do plateau. Three, despite being actively managed, the fund has stayed clear of instruments with doubtful credit quality. In the October portfolio, 59% was invested in triple-A while only 11.9% was in papers with AA+ rating. The focus on credit quality could become important in the months ahead as companies grapple with the lag impact of recent increases in interest rates. The average YTM is 9.7%, and the credit quality is high. The portfolio is diversified with 34 holdings and the top 5 holdings constitute 51% of the total portfolio. The fund has returned a commendable 8.96% in the past year as against the category average of 8.02%. The returns since launch have been 8.01%. The expense ratio is very low at 0.88%.

Birla Sunlife Government Securities Fund (LT) Gem

Incorporated in October 1999, Birla Sunlife Government Securities Fund - Long Term has an AUM of Rs. 382 crore. Risk-averse investors looking for relatively safe debt options in the mutual fund category can consider investing in Birla Sun Life Government Securities Fund Long Term Plan. With a compounded annual return of 11.3% over the last three years, the fund convincingly beat its benchmark I-Sec Li-Bex, by over four percentage points. Active management of interest rate risk and ability to identify and benefit from short-term technical abnormalities in the interest rate curve have ensured that the fund is among the top five in the medium and long-term debt funds category. While the name of the fund may suggest that it is a typical long-term gilt fund, the fund has a highly flexible strategy. It can take exposure to Government securities of both Central and State governments and can also invest in more short-term treasury bills. To this extent, it can take advantage of any rallying interest rate scenario by moving to short-term treasury bills. This not only protects the portfolio from any lacklustre performance in long-dated instruments but also peps up returns albeit for a short duration. A more important asset allocation mandate is that the fund can only invest in government securities. This effectively brings the credit risk of the fund's portfolio to almost nil as all government instruments come with a sovereign guarantee. The average yield to maturity of the fund is 8.77% and the credit quality is high. The portfolio has 5 holdings with Government of India securities constituting 98% and cash 2%. The fund has returned 7.32% in the past one year as against the category average of 6.4%. The returns since launch have been an impressive 9.43% and the expense ratio is 1.5%.

BSL Floating Rate Fund (ST) Gem

Incorporated in June 2003, Birla Sunlife Floating Rate Short Term Fund aims to generate regular income through investment in a portfolio comprising substantially of floating rate debt/money market instruments. The fund sports an AUM of Rs. 2200 crore. The YTM is at 9.29%, and the credit quality is high. Looking at the investment strategy, the scheme has invested in high-quality bonds, which are the safest bets. This conservative approach has helped the fund generate positive returns even when the market plunged in 2008. The portfolio has 17 holdings and the top 5 holdings constitute 52.24% of the total portfolio. Certificates of Deposit constitute 76% of the portfolio, cash 10%, term deposits 8%, and Commercial Paper 6%. The fund fetched 6.02% and 7.07% returns compounded annually for 2-year and 5-year period, respectively, while its benchmark stood at 5.01% and 6.52%. The fund has returned 8.84% in the past one year as against the category average of 8.47%. The returns since launch have been 6.53%. Having a lower expense ratio of 0.36% has been favourable for the fund.

FUND FLAVOUR
DEBT FUNDS

Ride the interest rate cycle…

With a series of hikes over the past year, interest rates have risen sharply and it is likely that they may inch up in the near future. While fixed deposits will fetch higher returns, debt funds may feel the pinch. This is due to the inverse relationship between bond prices and interest rates. When interest rates rise, bond prices come down, which, in turn, reduce the net asset value (NAV) of debt funds. On the other hand, falling interest rates result in a spike in the prices of the underlying bonds, leading to a rise in the NAV. So, when interest rates are increasing, debt funds become unattractive. This does not mean you should completely avoid debt funds as a category. A close scan can reveal funds that are likely to perform better than other fund types even in this scenario. So, if you know how to pick the right ones, you can benefit despite a rise in interest rates. The best way to select debt funds is to look at their maturities, apart from the quality of underlying assets and the liquidity offered. This goes a long way in determining how your debt portfolio will ride the interest rate cycle.

Gilt Funds
Making a comeback

Gilt funds, which lost their lustre due to hardening yields on government bonds, are slowly moving up the performance charts on the back of an increase in bond prices in recent months, thanks to the series of rate cuts undertaken by the RBI. The falling interest rates have translated into an appreciation in prices of long-term bonds and government securities alike. Medium and long term gilt funds, which invest primarily in government securities, have given 2.3% returns in three months, the best in the debt category. They moved up by nearly 0.7% in one month, just below sectoral equity funds and gold exchange-traded funds. Bond yields are expected to remain in the 7.5%-7.7% band. Of course, you must understand that to make the most of your gilt fund investments, being invested for the long haul (to cover an interest rate cycle) is important.

FMPs
The prodigal’s son

With the high interest rates, the rates on Fixed Deposits are also increasing, so why are investors looking for FMPs? Though FMPs are advantageous for all kinds of investors these work best for those who earn above Rs 5 lakhs and fall under the tax bracket of 30%. On bank fixed deposits you pay 10% TDS (you can avoid the TDS by submitting Form 15G) and another 20% tax on interest received on fixed deposits when you file the return for income tax (assuming that you pay personal income tax in the range of 30%), but in FMPs tax rate on capital appreciation is 11.22% without indexation( it is a technique to adjust income payments by means of a price index, to maintain the purchasing power of the public after inflation) and 22.44% with indexation benefit. Another advantage with FMPs is that they can be used to park funds temporarily in volatile markets. Most FMPs provide returns that are at least 2-3% higher than the rates of fixed deposits . So if the banks give an average of 9% now, you can expect around 11-12 % of returns.

Income funds
The black sheep

Income funds, which invest a majority of their portfolio in short- and medium-term instruments, were the worst performers in the debt fund category on account of a hardening of short-term yields due to the prevailing tight liquidity situation and expectation of a rise in inflation. Income funds gave a return of 0.84% as compared to 1.4% in gilt funds and 1.71% in liquid funds. Yield on the one-year Certificate of Deposit firmed up by 145 basis points and credit spreads across maturities widened as corporate bond yields hardened more than the yields on government securities. While this negatively impacted the performance of income funds, the short-term debt categories benefited.

Floating Rate Funds
Lacklustre presence

The primary reason for lacklustre presence of floating rate funds in the mutual fund industry has been investor ignorance of the nature of floating rate funds. There is a shortage of sufficient long-term floating rate instruments. Because of this, fund managers divert certain portion towards fixed interest securities. The primary advantage of these funds is that they are less volatile than other types of debt funds. This advantage arises due to the inherent structure of the floating rate bonds. Floating rate funds vary from conventional fixed rate investments mainly on the basis of coupon rate i.e. the coupon is revised at regular intervals (means floating) with respect to change in the benchmark rate. Consequently, if there is a rise in the interest rate, the coupon rate usually reflects this change, thereby, securing the interests of investors during rising interest rates. Usually investors turn to these funds when they look for safety for their investments. Considering the fact that not a single long term floating rate fund has slipped into the negative terrain suggests that the performance of the floating rate funds have been quite good. Investors looking for capital preservation during times of rising interest rates cannot afford to ignore floating rate investments. However, they must note that while floating rate funds do well in a rising interest rate scenario, when the scenario turns (i.e. interest rates fall), floating rate funds underperform their fixed rate counterparts.

Liquid funds
Attractive alternative to bank accounts

A recent study carried out by CRISIL Fund Services concludes that liquid funds offer an attractive alternative to retail investors vis-à-vis parking idle funds in a savings bank account. Not only do liquid funds offer higher post-tax returns, they also provide a reasonable degree of safety in terms of the principal invested. Moreover, these investments are highly liquid. They can be redeemed within 24 hours and have no exit load. Further, liquid funds invest in securities with a maximum maturity of 91 days, which cuts down the credit risk. Most liquid fund schemes are also highly rated (P1+f), signifying very strong protection against losses from credit defaults. Over the last 5 years, liquid funds have given an annualised post-tax return of 5.78% as compared to 2.5% given by a savings bank account. Within liquid funds the dividend option is more tax-efficient. This option would be more suitable for investors who fall within the 20% and 30% tax brackets, as it attracts a lower dividend distribution tax of 12.5%. Post tax deduction, liquid funds yield better returns vis-à-vis savings accounts and fixed deposits, wherein the interest earned would be taxed based on an individual’s tax slab.

…to savour the flavour of debt

Depending on the interest rate outlook, investors should alter their debt portfolios in favour of products with suitable maturities. Depending on the tenure, the sensitivity to interest rate movements varies across debt funds. Shorter duration funds are not affected as much by interest rate fluctuations as the long-term ones. So, if the rates are falling, you should invest in longer maturity debt funds, such as income funds and gilt funds. However, in a rising rate scenario, short duration plans such as liquid funds, ultra short-term funds and fixed maturity plans (FMPs) are the right choices. So it is advisable to have a debt fund portfolio with adequate allocation for various categories so that you are well placed to benefit from various phases of the interest rate cycle.