Should You Stay Away From Long Term Debt Funds Now?
May 25, 2015

Author: PersonalFN Content & Research Team

Impact Impact Indicator

There is a buzz in the market that the Reserve Bank of India (RBI) in its 2nd bi-monthly monetary statement for 2015-16 (schedule on June 2, 2015) would reduce policy rates, now that inflation has mellowed down. There are many out there advising investors to park their hard money in long term debt funds now. So, should you buy in to that advice?

Well, in the past one year, medium-to-long term gilt funds and income funds have delivered luring returns, with some even clocking double-digits. But of late, over the last quarter, they seem to be losing steam. This is because bond yields after falling for more than 18 months, have remained flat in the past three months.

In the last few days there is some pressure evident on yields and there are several factors responsible for this...

  • Global crude oil prices – Increase in global crude oil prices from the recent lows has inflicted risk to fuel inflation. Petrol and diesel prices have already been hiked twice in less than a month, by about Rs 7 and Rs 5 respectively a litre.

    Going forward with strong manufacturing data being posted by oil guzzlers of the world, and if tensions escalated in the Middle East; in all likely chances oil prices would trade at higher level than that at present… but this can be controlled if production rises.

  • Forecast of sub-normal monsoon – The Indian Meteorological Department (IMD) has released a statement that southwest monsoon this year would be sub-normal (due to an El Nino phenomenon). Such a prediction has also signalled risk to food inflation. The unseasonal rainfall in northern, central and western parts of the country in the last few months has already done some damage to crops. For agriculturist / farmers these are challenging times are so is it for consumers with a detrimental impact left on household budgets.

  • GDP Growth – The country’s economic growth has failed to pick up as expected despite an out-of-cycle rate cut by RBI and transmission of policy rates. While Q3FY15 GDP data shot up to 7.5% from 5.3% for the previous quarter, this was an effect of statistical jugglery. This is because the base year has been changed to 2011-12 from 2004-05 and so has there been a change in the methodology of calculating GDP, moving from factor cost to market prices. The RBI like many others has been cautious while reading into the GDP data, and has thus said leading and coincident indicators suggest a downward revision of these estimates when fuller information on real activity for the last quarter becomes available

    The Economic Survey 2014-15 has estimated that in the fiscal year 2015-16, the economy would show a growth of over 8% and possibly be placed in the double-digit trajectory in future. But the path to growth is hinged upon:
    • Implementation of key reforms (such as the Make in India);
    • Passage of vital Bills in the parliament (such as GST and the Land Acquisition Bill);
    • Infrastructure development;
    • Rationalisation of tax policy;
    • Progress of monsoon; and
    • Monetary policy action of the central bank

  • Sovereign ratings – Unlike Moody's action to upgrade India's outlook, Standard & Poor’s has not changed its outlook (kept it ‘stable'). According to S&P, the Centre's efforts to go for fiscal consolidation validates India's lowest investment rating, cautioning that its credit profile could face a downside risk from structural fiscal weakness. The ratings agency has cited that latest fiscal year deficit reduction hasn't come easy. Disappointing tax collections, especially service tax collection, dragged the estimated total revenue for the fiscal year ended March 2015 by 6.3% below the central Government’s initial budget projection. In a report titled ‘India’s Fiscal Roadblocks Could Stall Infrastructure Progress,’ S&P warned that any financial or commodity shock could unwind its recent fiscal improvements. It is noteworthy that while India could meet its fiscal deficit target for the fiscal year 2014-15, it was aided by eleventh hour gasp of payments worth Rs 10,808 crore by telecom companies for spectrum allocation and tax receipts in March 2015.

So, what stance RBI may take in its ensuing monetary policy review?

The stance of the monetary policy will be shaped up by the Monetary Policy Framework Agreement signed between the Government and RBI. The central bank would stay focussed on ensuring that the economy “disinflates” gradually and durably, with CPI inflation targeted at 6.00% by January 2016 and at 4.00% by the end of 2017-18.

Thankfully, both CPI and WPI inflation have mellowed and moderated - placed at 4.87% and -2.65% for April 2015. But that wouldn’t nudge the RBI from reducing policy rates in it 2nd bi-monthly monetary policy statement for 2015-16 (scheduled on June 2, 2015). It would simply prefer to maintain a status quo in June as the upside risk to food and fuel inflation persists as cited above. RBI may like to assess the following, amongst host of other factors before reducing policy rates:

  • Progress of monsoon;
  • Trend in global crude oil prices;
  • The impact of previous rate cuts on economic growth;
  • Fiscal deficit data;
  • The movement of the Indian rupee against the greenback;
  • The effort the Government takes on improving the state of physical infrastructure and introducing structural reforms to curb supply side constraints; and
  • Monetary policy stance of the Federal Reserve in the U.S.

What should be your investment strategy?

PersonalFN believes the longer end of the maturity curve is exposed to risk. Most of the rally has already occurred in the last one year and now the longer end of the maturity curve seems to be running out of fizz. Even if you want to take the risk and bet on the longer end of maturity curve, consider only dynamic bond funds to do so (as they are enabled by their investment mandate to take positions across maturity profile of debt papers) and provided you have an investment horizon of at least 3 years.

In case you have a time horizon of less than a year, you should stay away from funds with longer maturities. If you have a short-term investment horizon of 3 to 6 months you could consider investing in ultra-short term funds (also known as liquid plus funds). And if you have an extreme short-term time horizon (of less than 3 months) you would be better-off investing in liquid funds.

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