Mutual fund investors were a confused lot in 2004. While they saw equity funds grow from good to great, they watched haplessly while their debt funds slumped from bad to worse. Rising crude prices and inflation were the main culprits behind the depression in the debt market.
2003 marked the dawn of a new era which saw the debt fund investor grappling with the reality of single-digit returns. 2004 saw a hitherto unseen and even unanticipated event negative returns on long-term debt funds.
Bond markets were relatively stable with the 10-Yr Government of India (GOI) bond yield hovering around 5.10% at the start of the year. The monetary policy announced in May left CRR (cash reserve ratio) and the Bank Rate untouched indicating that the Reserve Bank of India (RBI) was keen on maintaining a status quo on interest rates.
However, that was little consolation for the debt fund investor in view of what was to unfold over the months. It was triggered by a sharp rise in global crude prices, which brought inflationary concerns into the foreground. Bond markets went in a downward spiral and the 10-Yr GOI dived to 7.20% levels. The danger presented by inflation was real and present, a fact not lost on the RBI. In the October Monetary Policy, the RBI raised short-term interest rates by hiking the repo rate by 25 basis points (0.25%) to 4.75%. Although it left the Bank Rate unchanged, it raised its projection for (the point-to-point) inflation for the year 2004-05 (FY05) to 6.5% as compared to 5.0% projected earlier.
Inflation takes a toll¦ | Long-Term Debt Funds | NAV (Rs) | 1-Mth | 6-Mth | 1-Yr | 3-Yr |
| BOB INCOME G | 11.66 | 0.30% | 1.68% | 5.21% | NA |
| LIBRA BOND G | 12.61 | 4.13% | 3.45% | 4.61% | 5.93% |
| ESCORTS INCOME PLAN G | 20.54 | 0.44% | 1.71% | 4.59% | 9.56% |
| CHOLA FREEDOM INCOME C | 10.52 | 0.51% | 1.99% | 3.89% | 6.94% |
| CANCIGO | 13.93 | 1.75% | 8.91% | 3.65% | 11.14% |
(Source: Credence Analytics. NAV data as on Dec. 30, 2004. Growth over 1-Yr is compounded annualised)
Expectedly, inflation took its toll on long-term debt funds and for the first time debt fund investors saw year on year fall in value of debt funds. While debt fund investors had witnessed volatility in the past for some time, an erosion of this magnitude is something that was not given due consideration. At Personalfn, we have been advocating floating rate funds for some time now to blunt the volatility in debt funds, which was a regular feature over the last 2 years. Floating rate instruments have their coupon revised at regular intervals and are not as adversely affected by debt market volatility as fixed rate instruments.
So its not surprising that 2004 was a year that saw a lot of investor interest in floating rate funds. As several fund houses did not have a floating rate fund in their arsenal, there were some floating rate fund IPOs (initial public offerings). That and dynamic funds (that actively manage bond and gilt components) were the only schemes that dotted the IPO horizon this year.
What to expect in 2005?
Leading fund managers recommend that in 2005 long-term debt funds make a return in the investor's portfolio because going forward with a 12-18 month horizon, debt funds will likely be in positive terrain. Mr. Nilesh Shah (CIO PruICICI Mutual Fund) sounded confident in an interview with Personalfn: We expect debt and g-sec funds to generate positive returns in the range of medium to higher single digits from here onwards. In another interview, Mr. Binay Chandgothia (Deputy CIO and Head Fixed Income Principal Mutual Fund) echoed the positive sentiment, Retail investors should start investing in smaller quantities in debt funds.
At Personalfn we suggest that debt fund investors with a horizon of less than 6 months, continue to invest in floating rate funds. Only if the investor has a time frame of over 12 months should he consider investing in long-term debt funds and even then gradually. Mr. Nilesh Shah affirms, In the short term there are still uncertainties mainly because of inflation and hence we are recommending gradual entry into debt funds at this stage.
It is apparent that volatility in debt markets cannot be ruled out in 2005. However, you can counter this by being invested in the right debt fund avenue. Hopefully, this will insulate your portfolio in 2005 from a lot of uncertainties that plagued the markets in 2004.
Add Comments