In our story last week, we had highlighted how debt fund net asset values (NAVs) were under pressure from rising bond yields. The major correction in bond prices had left investors with a big hole in their debt fund investments. The situation shows no signs of improving as bond prices continue their downward journey.

The question uppermost in the minds of most investors is how long will the decline continue. (Read our story Is it time to exit debt funds?) When there were initial signs of volatility last week, it was attributed to the war among other things. After that, most funds came out saying that the worst was behind them and current prices already reflect that. However, the slide in bond prices continues and investors are getting increasingly jittery about their debt fund investments.

Still sliding¦

Income Funds (Long Term)	NAV (Rs)	1-Wk	1-Mth	6-Mth	1-Yr	Incep.
PRU ICICI FLEXIBLE INCOME PLAN	10.2	-4.3%	-6.8%	NA	NA	1.8%
LIBRA BOND G	11.3	-2.3%	-5.7%	1.4%	1.5%	8.7%
GRINDLAYS DYNAMIC BOND	10.7	-1.9%	-4.1%	4.9%	NA	6.6%
CHOLA TRIPLE ACE G	20.3	-2.2%	-4.0%	4.3%	9.2%	12.7%
TEMPLETON INC. BUILDER ACC G	20.7	-2.3%	-3.9%	5.5%	10.5%	13.8%

(NAVs as on Feb. 14, 2003. Growth over 1-Yr is compounded)

These funds had their fund managers turning opportunistic over the past few months and buying securities at the longer end of the yield curve. With such a high portfolio maturity (over 7-8 years) this was always going to be a high-risk investment strategy in times of interest rate volatility. Note PruICICI Flexible Income Fund dipped nearly 7% in a month. In The Survivors below Templeton Floating Rate Fund clocked 7.3% in a year! That is what interest rate volatility can do to your investments - it can take away the gains of an entire year in one bad month.

The Survivors¦

Income Funds (LongTerm)	NAV (Rs)	1-Wk	1-Mth	6-Mth	1-Yr	Incep.
HDFC FLOATING LTP G	10.1	0.1%	NA	NA	NA	0.3%
SUNDARAM SELECT DEBT-3YR	10.2	0.1%	0.4%	NA	NA	2.2%
TEMPLETON FLOAT LTP G	10.8	0.1%	0.4%	3.3%	7.3%	7.3%
UTI REGULAR INC.	10.2	-0.9%	-1.6%	NA	NA	2.1%
UTI VARIABLE INV. ILP	10.0	-0.3%	-1.7%	NA	NA	-0.4%

(NAVs as on Feb. 14, 2003. Growth over 1-Yr is compounded)

Some of these debt funds (the floating rate schemes) were insulated from interest rate volatility largely due to the scheme framework. Floating rate schemes invest in paper that has its coupon rate adjusted periodically. This acts as a hedge against volatility. Other funds kept volatility at bay by investing in shorter maturities. For instance, Sundaram Select Debt  3 year invests only in paper maturing in 5 years on the outer side.

Investors who are already invested in debt funds for over 6 months don't yet have a cause for concern if their investment horizon at the time of investment was for over a year. They are still in the positive and are unlikely to see their investments go negative over that period. Even if the interest rate volatility extends indefinitely, income fund managers have taken adequate steps by going into shorter maturity paper.

Some nervous investors have written to us asking us if its worthwhile shifting to a liquid fund/short term plan and then re-entering the income fund at a lower net asset value (NAV). Some portion of your assets can be re-allocated to a liquid fund/short/floating term plan to stem losses from falling bond prices. However, you need to realise that there is a cost of shifting funds by way of load. Most long-term income funds have a minimum investing period that investors need to adhere to in order to avoid the load. A more prudent way of investing is to take a longer view on markets (debt and equities) and let the fund manager do all the monitoring. For instance, you may want to move to a liquid fund to stem losses, but your fund manager would already have done that by shifting to cash and shorter term paper in the event of a decline in bond prices.

However in our view, more important than reallocating your funds, you need to keep an eye on the average maturities of your debt fund manager's portfolio. Until a few months ago, a lot of investors were very pleased at clocking above-average returns on their debt fund investments, not realizing it was largely due to large investments in longer dated paper. So the portfolio maturity can be the key and any signs of the fund manager going above board on longer dated paper must ring alarm bells. How are debt funds likely to fare in 2003? Download your FREE copy of Money Simplified, the online guide to Personalfn to get an idea.

Nevertheless, over the last 10 days or so, investor perception about debt funds would certainly have received a hard knock. Debt funds that have long been perceived as an investment avenue that fulfills the investor's need for a steady and predictable income flow, have undergone a gradual transformation over some time that investors are noticing only now. Like their equity peers in the industry, debt funds have also assumed a profile that needs considerable and regular monitoring. And like equity funds, they are subject to enough volatility to make investors nervous and jittery.

This is where professionalism comes in. As your investments get exposed to more and more uncertainty, gone are the days of application form peddlers. This is the age of investment consultants who are both experienced and qualified to give you unbiased and independent advice. They understand the nuances of debt and equity-linked investments and adopt a more knowledge-based approach. So when you need to select an investment consultant ensure he fits into the criteria we have outlined.

 

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