Insights

Latch onto opportunities in short-term debt funds

October 30, 2013 . Vidya Bala
The latest MSF rate cut, together with liquidity easing measures would mean a price rally in short-term debt instruments for some more time.

The RBI’s second quarter review of monetary policy led to a brief relief rally in the equity, debt and currency markets as the measures were in line with market expectations.

The RBI increased the repo rate by 25 basis points to 7.75% and reduced the MSF (Marginal Standing Facility) rate by 25 basis points to 8.75%. With this, the rate differential between repo and MSF has moved back to normal policy operations (with difference of 100 basis points). This rate corridor was disturbed when the RBI imposed liquidity constraints on the markets in July, to curb the falling rupee.

In a bid to improve liquidity in the system, the RBI also announced increasing the liquidity available for banks through term repos of 7-day and 14-day tenure, from 0.25% of bank’s NDTL to 0.5% now. That means, banks can now borrow twice the amount of funds they could earlier, at lower than MSF rates.

Key takeaways
– The MSF rate cut and measures to ease liquidity will further ease rates in the short-end of the yield curve. As acknowledged by RBI, between mid-September and October, money market rates fell by 125 basis points. The latest cut together with liquidity easing measures would mean a price rally in short-term debt instruments for some more time.

Debt funds with short-term maturity have rallied over 1% on an average between the last monetary policy and now and saw gains as much as 1.7% in a span of a month.
Investors can look at liquid, ultra short-term and short-term funds, based on the time frame for which they need to invest; the first being meant for those with the shortest time frame and the last-mentioned for time frame of at least 2 years.

– While 10-year gilts fell 6 basis points to 8.58% soon after the policy was announced, this may be seen more as a relief rally. Going forward, with rate decisions hinging mainly on retail inflation, any rally in long-term gilt prices may be unlikely. It would be prudent for investors to avoid any fresh exposure to long-term gilt funds at this juncture.

Outlook
Even as the RBI expects food inflation to come down, it expects retail inflation to remain at around 9% in the coming months, absent policy action.

While this statement suggests a hawkish stance, it may also be noted that any rate hike in the coming calendar may disturb the liquidity easing measures done so far. It may also affect the higher fund demand that typically arises in the last quarter of a fiscal.
As a result, such a hike could also mute the 5% GDP growth that the RBI expects for FY-14. Viewed from this angle, a near-term rate hike would require strong economic triggers.

 

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4 thoughts on “Latch onto opportunities in short-term debt funds

    1. Hello Ram, Fund recommendations will vary even withing the category based on individual need and time frame. Hence, pl. use our Ask advisor feature for choosing funds. thanks, Vidya

  1. Madam, what would be the impact of the present policy of RBI on Dynamic Bond funds (e.g., SBI Dynamic Bond Fund), other Income funds (e.g., SBI Income Fund) and medium-term Gilt funds?

    1. Hello Sir, the impact is varied across income funds based on their maturity profile and strategy. Dynamic bond funds with lower average maturity of say 3 years or so will not be impacted and may slowly gain as well. But those with longer maturity (like SBI Dynamic) as well as medium to long gilts will not see any rally until the rates start declining. They will remain quite volatile. For fund specific advice, pl. use our ‘Ask Advisor’ feature in your FundsIndia account. thanks.

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