Caution is the byword

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: The events of the last few months have made debt funds extremely cautious about liquidity mismatch
Ideally, debt funds should have celebrated the turn of events. Interest rates have peaked; investors are looking for options outside equity; corporate borrowers are starved for funds; and mutual funds remain the only large intermediary in the long-term market for debt. However, the events of the last two months seem to have put a spanner in the works, and funds have become extremely cautious about their portfolios. While funds have always remained sensitive to credit risk, they were willing takers of market (interest rate) risk. They also played a liquidity intermediation role, investing in illiquid debt paper while providing ready liquidity to their investors. The stress from liquidity demands have now converted debt funds into staid products that would not only have a conservative portfolio, but also one that matches maturity profiles on both sides of the balance sheet, very closely. One hopes that after a brief phase of withdrawal, mutual funds will come back with debt products that enable channeling the savers’ funds into long-term debt markets. We badly need those long-term debt funds.

Gilt funds catch investor fancy
Investor interest in short-term government security funds (gilt funds) has increased. Those that look for the security of government borrowings, and the low volatility of short-term debt instruments seem to like this product. Gilt funds had been launched in 2001-02 to serve the needs of provident funds that invest predominantly in government securities. But before they got the approvals from the Labour Ministry and decided to invest in 2004, the cycle had turned. Gilt funds shrank in size during the period after 2004, due to lack of interest in a rising interest-rate scenario. Now interest is reviving, both from institutions seeking better returns, and retail investors seeking safety.