Cash Funds: Add More Punch To Your Portfolio

Updated: Jun 30 2002, 05:30am hrs
Are you looking for avenues other than bank fixed deposits to park your capital Or would you rather have another investment option, apart from stock markets, that allows you the comfort of high liquidity For investors with such requirements, cash funds could be a good option. How Cash funds hold more punch than a short-term bank deposit. If you are willing to take little risk for some extra return, they could be a worthy proposition. These funds largely invest in money market instruments like treasuries and commercial paper, issued by corporates. Moreover, short-term losses elsewhere can offset gain in these funds.

The minimum investment for these funds could start from as low as Rs 5,000 to as high as Rs 1 lakh. But for differential gains to be meaningful in absolute rupee terms, investment here make sense only if you have a sizeable cash position Rs 1 lakh or more. For big investors cash funds could be a better deal than short-term bank deposits and savings accounts.

Budget 2002 has made dividends from all bond funds to be taxed at the hands of the investor, in accordance with the tax bracket an individual falls into. Also, while the limit of interest income from bank deposits has been reduced from Rs 12,000 to Rs 9,000, banks also deduct tax at source on interest above Rs 5,000. With increased interest rate volatility, cash funds prove to be a safe haven for steady returns. As rates rise, bond prices fall and vice-versa. Incidentally, the impact of rate cuts is not the same on all bond funds; it varies from one to fund to the other. Shorter-duration funds are less interest-rate sensitive and have historically offered less upside potential than funds with a longer duration. Falling interest rates gave bond funds a big boost, as was evident last year. While medium- and long-term bond funds were the biggest beneficiaries, short-term funds made some substantial gains. As of today, the charm of cash funds has reduced considerably. No one thought that bond returns would take such a hit as they did in the months of April and May this year.

In the year 2001, the Reserve Bank of India had announced unprecedented rate cuts on three occasions. This ideally should have been wonderful news for people looking at refinance options but it has not been so in the case of short-term fixed income investors. Reason: Money market yields move in tandem with prevailing short-term interest rates.

Despite the fact that last year cash funds clocked an annual average return of 8.37 per cent, lower than the 9.1 per cent return turned by them in the year 2000, still these funds are a worthwhile offering. In 2001, falling interest rates and an economic slowdown gave bond funds a big fillip, particularly long-term bonds, which registered sharp movements during the year. On the other hand, short-term fund category too posted decent returns. If interest rates move up, this increase would hike the short-term bond yield too. Average return for the first quarter of 2002 stands at 1.72 per cent a 23 per cent fall over last year.

Before you consider replacing cash with a cash fund in your portfolio, look beyond yields. Anyway, the yield difference of the best and worst fund in this category on average is hardly anything. I suggest that you place a premium on low expenses, besides stability and consistency. As short-term bond investors wouldnt like to be taken by surprise. That part, they value low volatility.

My picks among cash funds include:

Alliance Cash Manager: This fund doesnt take chances. Launched in May 1998, it sticks to AAA bonds and P1+ securities, which eliminates chances of both credit and liquidity risks. Since launch, the fund has clocked an 8.77 per cent return while and its year-to-date (YTD) return is 3.54 per cent.

Birla Cash Plus: Another choice that keeps a lid on volatility and provides minimal credit risk. Launched in June 1997, the fund has turned in a 9.14 per cent return since launch and its YTD return is 3.58 per cent. This funds portfolio comprises commercial papers, treasury bills and AAA debentures besides parking some portion in call money.

DSPML Liquidity: This fund is pretty steady. Launched in March 1998, it aims to generate reasonable returns commensurate with low risk and high liquidity by investing about 80 per cent of the corpus in money market instruments, with the remaining accounted for by debt instruments. The fund has registered 8.22 per cent return since launch and its YTD return stands at 3.61 per cent.

Value Research