As if the equity markets weren’t bewildering enough last week, the RBI decided to puzzle you on the debt front as well. If you had a chance to see your portfolio of debt funds, especially gilt or income funds in the just ended weekend, you would have been surprised to see a spurt in your NAVs in the last one week – A La Usain Bolt sprint.
On an average gilt funds rallied 3.7% (absolute gain) from close of August 20, (when the RBI measures were announced) while income funds moved up by 2.1%.
Clearly funds with longer-dated maturities (typically gilts) rose sharply.Popular income funds such as Templeton India Income Builder, SBI Dynamic Bond and IDFC Dynamic Bond too delivered 3.3-3.5% in a single week.
So what triggered this quick rally and should that mean a reversal in the yield hikes you saw since July?
Just to answer it straight, a few, rather surprising (confusing too) measures done by the RBI resulted in a fall in long-term yields, resulting in a rally in the price of such instruments.And no, this does not right away mean you are in for a rally in debt. You will have to wait and perhaps also move with care.
The moves
RBI announced a few measures on August 20 to stabilize the bond markets; after its liquidity tightening measures (to contain the rupee fall) continued to adversely impact bond prices.
One, the bank announced open market operations, where it sought to buy long-dated bonds from the market. Buying bonds would result in reducing volatility in the long-bond market and cause the price of bonds to rally. This would also release rupee in to the system (thus actually causing the rupee to depreciate further).
Two, the Central Bank allowed banks to hold more securities in the held-to-maturity category from held for trading/available for sale category. That simply means securities shifted to held-to-maturity category need not be marked-to-market. That means, banks’ balance sheet need not provide for the losses every time the price of bonds they held fell.
Also the marked-to-market losses suffered thus far could be depreciated by the banks over the rest of the financial year (as opposed to the September quarter end for this quarter).
These measures, clearly, were meant to provide some relief to banks as it would keep them from any capital hit and instead, have enough credit for the industries, without hiking lending rates.
The policy also hinted at keeping liquidity tight (until currency volatility reduces) by keeping short-term rates elevated.
Now, these measures hint at a few issues that the RBI may not openly state: one, the July measures did not really help curtail the rupee fall and instead caused too much volatility in long-term bonds.
For its own good (given that long-term gilts are nothing but borrowings made by the government), the government had to curtail the excessive volatility. Two, the government does not want to sacrifice growth even as it wishes to stabilize the rupee.
What it means
As far as you are concerned, the rally may have been a welcome relief for your languishing funds. But if you wish to jump into the gilt bandwagon believing that you may be in for some quick bucks, be careful. While those holding gilt or income funds with a minimum 2-year time frame have little to worry, the latest rally should not be construed as a sign for short-term investment opportunities in gilt.
It is very likely that India will be directly exposed to the U.S dollar movement and the real US interest rates as long as its current account deficit remains at high levels. That means, any upward rate movement in the U.S is likely to have influence locally as well. That means, the current measures do not entirely make our bonds immune to further volatility.
Your investments
While you can stay put with your current gilt or income fund investments, fresh investment for a 1-2 year period may be best made in short-term funds or fixed maturity plans (FMPs with a 1-year tenure). The RBI’s intention is to keep short-term rates elevated for some more time to keep its tight liquidity stance. But then this may be slowly softened as hinted by it.
Hence, with short-term funds, while there may be near-term volatility, it could be followed by a rally. Even if such a rally does not happen, if the funds are held close the underlying portfolio’s maturity (1-2 years) their returns could be healthy as portfolio yields are on an average upward of 10%. With FMPs, the risk of the volatility too, is low, as the instruments would be held to maturity.
A number of fund houses are now issuing FMPs which mostly invest in certificates of deposits or commercial paper, both of which are typically of high credit quality.
That said, for those with a long-term view (of not less than 2 years), income funds remain a preferred option.
Check our list of select funds – Debt 1-1.5 years for short-term funds and our FMP/NFO list for FMPs. As of today (Monday Aug 26), FMPs from ICICI Pru Mutual, DSP BR Mutual, Kotak Mutual, Peerless Mutual and L&T Mutual have FMPs with a 1-year tenure.
Wealth Conversations – April 2024- Temporary suspension of subscriptions in ” Mirae Asset Global Electric & Autonomous Vehicles ETFs Fund of Fund & Mirae Asset Global X Artificial Intelligence & Technology ETF Fund of Fund
- Merger Announcement: Aditya Birla Sun Life CRISIL IBX AAA Mar 2024 Index Fund
Here is everything that you need to know about Arbitrage Funds- Temporary suspension of subscriptions in “DSP US Treasury Fund of Fund”
if some one has a 1.5 – 2 yr horizon, duration funds at the current levels are too attractive to consider. http://www.ddramanathan.blogspot.in
Thanks again madam.
And, welcome back, hope you have a very good and much needed break… 🙂
Regards,
Sunil.
if some one has a 1.5 – 2 yr horizon, duration funds at the current levels are too attractive to consider. http://www.ddramanathan.blogspot.in
Thanks again madam.
And, welcome back, hope you have a very good and much needed break… 🙂
Regards,
Sunil.
Good Article. They are back down to where it was after yesterday’s carnage.
Thought of investing in dynamic bonds with an horizon of one year to beat FD returns, I am worried now whether it will even beat Savings account returns leave alone FD.
Hi Rakesh, it is likely that ultra short-term bond funds, short-term funds and FMPs will beat FDs if you have a 1 year view. Income fudns though are suitable only with a view of 2 years plus. tks, Vidya
Good Article. They are back down to where it was after yesterday’s carnage.
Thought of investing in dynamic bonds with an horizon of one year to beat FD returns, I am worried now whether it will even beat Savings account returns leave alone FD.
Hi Rakesh, it is likely that ultra short-term bond funds, short-term funds and FMPs will beat FDs if you have a 1 year view. Income fudns though are suitable only with a view of 2 years plus. tks, Vidya
Madam,
I would be grateful if you kindly explain the risk-return of NCD of a Company (rated AA+ by CARE) vis-a-vis risk-return of 1 year FMP of an eminent Fund House. I am planning to go for NCD in near future considering the present volatility of equity as well as bond funds.
Regards,
Partha
hello sir, Imagine, yourself putting money in a mix of deposits and bonds, versus investing in a single NCD. That is the diff, between a FMP and NCD. FMPs will invest in a basket of debt instruments. Also, most FMPs seek to invest in reasonably high quality instruments, esp. if they are just with a 1 year tenure. Of course, they will have diff. mandates, it could be a basket of pure certificates of deposits from banks or a mix of CDs, commercial paper and NCDs and bonds. That will be stated in the offer document.
Hence, you are effectively diversifying your risk by investing in an FMP. More importantly, an FMP held for 1 year and more will get capital gains indexation benefit, whereas a NCD interest will be added to your income and taxed at your alb rate – 10, 20 or 30% as the case. In other words, even a 12%b NCD could deliver actual returns of 8.4% if you have a 30% tax. hence, FMP is far more tax efficient. thanks, Vidya
Hi Vidya ,
If a person is in 30% tax slab and wish to invest in Income Fund , so pls elaborate advantages and disadvantages of Income Fund.
a) What is diff or advantages between Income Fund & FMP ?
b) Does Income fund comes with Growth options ?
c) Can we get indexation benefit on Income fund ?
d) If yes , than to get indexation benefit , how long should someone hold the Income fund.
As always shall wait for your favourable advice.
thanks,
Arun.
Hello Arun,
1. Income funds are for the long term, ideally with a 3 plus year holding and in some cases min of 2 years. Advantages: they would invest across debt intruments, CD, CP, bonds, gilt and get both accrual income (interst) and capital appreciation. disadvtg: can be volatile in the short term esp. when interest rate climate is uncertain. FMPs buy and hold instruments hence what you get finally is only the acrrual (interest) of the underlying instruments. But that makes FMPs less risky and uncertain.
2. yes it does.
3. Indexation benefit available if held for more than 1 year
4. More than 1 year. Indexation benefits are same for all FMPs and debt funds.
thanks
Hi Vidya ,
If a person is in 30% tax slab and wish to invest in Income Fund , so pls elaborate advantages and disadvantages of Income Fund.
a) What is diff or advantages between Income Fund & FMP ?
b) Does Income fund comes with Growth options ?
c) Can we get indexation benefit on Income fund ?
d) If yes , than to get indexation benefit , how long should someone hold the Income fund.
As always shall wait for your favourable advice.
thanks,
Arun.
Hello Arun,
1. Income funds are for the long term, ideally with a 3 plus year holding and in some cases min of 2 years. Advantages: they would invest across debt intruments, CD, CP, bonds, gilt and get both accrual income (interst) and capital appreciation. disadvtg: can be volatile in the short term esp. when interest rate climate is uncertain. FMPs buy and hold instruments hence what you get finally is only the acrrual (interest) of the underlying instruments. But that makes FMPs less risky and uncertain.
2. yes it does.
3. Indexation benefit available if held for more than 1 year
4. More than 1 year. Indexation benefits are same for all FMPs and debt funds.
thanks
Madam,
I would be grateful if you kindly explain the risk-return of NCD of a Company (rated AA+ by CARE) vis-a-vis risk-return of 1 year FMP of an eminent Fund House. I am planning to go for NCD in near future considering the present volatility of equity as well as bond funds.
Regards,
Partha
hello sir, Imagine, yourself putting money in a mix of deposits and bonds, versus investing in a single NCD. That is the diff, between a FMP and NCD. FMPs will invest in a basket of debt instruments. Also, most FMPs seek to invest in reasonably high quality instruments, esp. if they are just with a 1 year tenure. Of course, they will have diff. mandates, it could be a basket of pure certificates of deposits from banks or a mix of CDs, commercial paper and NCDs and bonds. That will be stated in the offer document.
Hence, you are effectively diversifying your risk by investing in an FMP. More importantly, an FMP held for 1 year and more will get capital gains indexation benefit, whereas a NCD interest will be added to your income and taxed at your alb rate – 10, 20 or 30% as the case. In other words, even a 12%b NCD could deliver actual returns of 8.4% if you have a 30% tax. hence, FMP is far more tax efficient. thanks, Vidya