Tough times ahead: Debt fund managers brace for new normal

Written by Ashley Coutinho | Ashley Coutinho | Mumbai | Updated: Sep 25 2013, 17:44pm hrs
Debt schemesDebt fund managers may have to be on their toes and tweak their strategies in managing long-duration bond funds as yield movements
Debt fund managers may have to be on their toes and tweak their strategies in managing long-duration bond funds as yield movements are likely to remain volatile in the coming months.

Volatility and uncertainty have become the new normal now and fund managers will have to cope with it, said Killol Pandya, senior fund manager debt, LIC Nomura MF.

The RBI indicated last Friday that it will react as and when the need arises rather than just effect changes from policy to policy. This means fund managers have to become a lot more watchful and agile now.

Industry observers believe that in the last 1-2 years most fund managers had chosen to focus on the duration play to benefit from the interest rate movement, which had become quite predictable during former RBI governor D Subbaraos tenure.

The unpredictability that the new RBI governor has brought in makes the job of a fund manager complicated. Fund managers will now have to look at avenues other than just the duration play to generate alpha returns, said a senior fund official.

Experts suggested that taking credit calls may become more popular going forward.

Fund managers will have to assess the credit quality of debt papers more closely now to see whether they are overvalued or undervalued. Fund managers may also look to move down the credit curve to generate alpha returns, said the official quoted above.

According to Dhruva Chatterji, senior investment consultant, Morningstar India, some money may move from longer duration products to short tenure products such as short-term bond funds or ultra short-term bond funds as investors look to avoid duration risk. Durations (of long duration bond funds) are likely to be moderated going forward, said Chatterji.

In August, fund houses had raised the average maturity period for their long durations funds over the previous month. For example, the average duration of Morningstar India long-term government bond funds rose to 11 years in August from 9.5 years in July.

Debt funds had enjoyed a good run in FY13, with long-duration bond funds giving returns of over 9% in a benign interest rate environment.

Experts believe that fund houses had become a bit over-confident in taking duration calls. For instance, on May 23, Birla Sun Life MF released a report titled 'Bond 007', making a case for yields of the

10-year government securities to breach the 7% levels by the end of the current rate cycle.

Similarly, HDFC MF had put up hoardings across Mumbai with the tagline Debt Mutual Funds help achieve your financial goals as part of its investor education and awareness initiative.

Last Friday, absolute one-day returns of long duration bond funds declined anywhere between 1.5-2.5% as yields on benchmark 10-year bonds rose 36 basis points to 8.559% over the previous day.

This is perhaps the second biggest jolt to the return of long duration bond funds in the last three months. On July 16, returns of some income and gilt medium-&-long-term debt funds had declined 3-4% following RBIs liquidity tightening measures.