FUND FLAVOUR - DECEMBER 2008

FUND FLAVOUR

Debt Funds

Dime (Debt Funds) a dozen…


Mutual funds offer a wide bouquet of debt funds. The recent hardening of interest rates has opened up a lot of opportunities for those looking to invest in debt instruments. Depending upon your investment horizon, tax status and liquidity needs, you can make your choice. Of course, no investment is without risk. But as long as you make an informed investment, you can minimize the risks and maximize the returns.

Here is a look at the different avenues in debt instruments and how they have fared in the year gone by…

Gilt Funds

G(u)ilt free edge…

In October 2008, the mutual fund industry witnessed a massive loss in its average assets under management (AAUM) of over Rs 97,000 crore. However, a small segment of debt schemes managed to buck the trend — gilt funds. We have witnessed aggressive monetary easing across the globe in response to the credit crisis... In India, RBI has also cut its key rates in recent months to ease liquidity pressures. This has led to a decline in bond yields, helping the performance of gilt funds. Over the past one year, till October 24, 2008, medium- and long-term gilt funds have been the best performing category among debt funds. Some top-rated gilt funds are giving a return of over 20 per cent. Short-term gilt funds collected the maximum, over Rs 1,500 crore, and the medium- and long-term category netted another Rs 70 crore. In fact, the short-term category’s AAUM is up from a paltry Rs 501 crore to Rs 2,018 crore. While the medium-and-long-term (over one year) category average returns is at 9 per cent, some of the bigger funds have been able to give really good returns — ICICI Prudential Gilt Investment (17.15 per cent), many others have given returns between 14 and 16 per cent. Even the short-term gilt category (less than a year) has given returns of 6.44 per cent.

Fixed Maturity Plans

The Blockbuster goes bust…

In September 2008, returns were on the upswing, thanks to tighter liquidity conditions. FMPs launched in September were offering indicative returns (mutual funds can only indicate and not guarantee returns) of around 11 per cent for both short- and the long-term FMPs. This has now come down to the range of 9.95-11.10 per cent. However, this is still higher than the returns indicated by funds over a year ago. In September 2007, three-month FMPs’ indicative rates were around 8-8.30 per cent, and for over 12 months, they were hovering around 9-9.50 per cent. While the longer duration FMPs are still indicating returns of around 10.5 per cent, the shorter duration ones have begun downward revisions in the indicative yields.

A downward revision in the returns coupled with concerns over the quality of the paper held by FMPs has led to retail investors shying away from FMPs now. This was attributed to the fact that many of them had invested significantly in commercial papers (CPs) and bonds of real estate companies and non-banking financial institutions (NBFCs).There were strong rumours that many of these companies were unable to repay the fund houses on time, leading to rollover of schemes. This fuelled fears that many schemes would be forced to default. When all fund houses declared portfolios of their schemes because of the half-yearly results, it dawned on the investors that the real portfolios were a far cry from the indicative portfolios.

FMPs faced severe redemption pressures in October, 2008 a month which saw the Bombay Stock Exchange’s benchmark Sensex fall a record 23 per cent. According to October-end data, the average assets under management (AAUM) of FMPs stood at Rs 127,080 crore, down Rs 10,718 crore in a single month. Over 25 per cent of the entire AAUM of the mutual fund industry is in this one product. SEBI confirmed that it will make early withdrawals from FMPs tougher, a move that is expected to solve mutual funds’ liquidity problems. At present, investors can exit FMPs by paying 2 per cent of the NAV at any point of time.

Debt Income Funds

Indebted…

The performance of debt income funds has not been very inspiring of late. In fact, even short-term income funds have outperformed longer-term income funds. This is because fund managers of income funds buy debt instruments of varying maturities. In a rising interest rate regime, the market price of bonds fall, as their yields rise, especially those of longer maturities, making longer term debt portfolios suffer a mark to market loss. In the past year short-term income funds have returned 6.68 per cent while long-term debt funds have returned only 5.32 per cent. This avenue of investment does not look very attractive in a rising interest rate scenario. These funds are ideal for people on the verge of retirement or those with moderate risk appetite.

Floating Rate Debt Funds

No longer floating…

Floating rate debt funds are linked to floating rate of return, which change with bond yields and interest rates fluctuations. This means that ideally, floating rate funds should not incur a mark to market loss on their debt portfolio in a rising interest rate scenario. However, returns of these funds have been quite low, with short-term funds returning more at 7.05 per cent than longer-term funds at 6.88 per cent. These funds have given an average return of about 7-8% over the last 6 months to 1 year, which on post-tax basis works out to about 6.15-7%. Similar have been the FD rates; but the post-tax returns work out to around 5.3-6.1%. Though these funds are a better choice over debt income funds in the present scenario, their returns do not make them a preferred vehicle of investment for longer-term investments.

Liquid Funds

Melting in the mouth…

Liquid funds have traditionally experienced considerable volatility in their assets, as their key investors are institutions and corporate treasuries rather than retail investors. Redemptions from liquid funds spiked in March, June and September 2008, following historical patterns as these are months when companies may need additional liquidity to pay taxes and advance taxes. However, redemptions this year have also been influenced by tightening liquidity over the past four months, corporates facing a funds crunch and an investor flight to safety. In the last one year, liquid funds have returned between 7.7 per cent and 8.85 per cent. Liquid-plus funds, on the other hand, have slightly higher returns between 8.4 and 11.29 per cent. Obviously, that makes them a better choice as against money earning a dismal 3-3.5 per cent in your savings account. But worries about a deteriorating credit environment have led to corporates and institutions moving to fixed return investments such as fixed and bulk deposits as also hard cash. Interest rates on alternatives such as bank deposits started to rise sharply in the second half of the year. These offered attractive and safer options, atleast for high net worth investors, which may explain some of these non-seasonal redemptions.

Concern of the conservatives…

Debt is not a homogeneous set of assets. This variety offers much better control over returns and risks compared to equity, and is thus ideally suited for the more conservative investors. This image of debt funds have taken a severe beating in recent times. In some of the papers, yields on the securities have crossed 50%, which is an indication that the market is beginning to price in a possible default risk on these investments. The bonds are quoting at yields of 27-60% against 12-16% a year ago. A few portfolio managers could well be investing a slice of their corpus in these papers. So how do these discounts or higher yields affect a company’s profile over a period of time? If bonds trade at a huge discount to their issue price for a sustained period of time, it will certainly affect the company’s ratings. A concern indeed for the diehard conservatives.