Long-tenure bond funds faced a turbulent quarter as the central bank?s liquidity tightening measures to curb the rupee?s fall and an unexpected hike in the key policy rate led to a spike in yields, which, in turn, impacted returns.

Gilt medium & long-term funds emerged as the worst performers for the three months to September 2013, with average category returns of -5%, data collated from Value Research, a mutual fund tracker, show. Income funds also ended the quarter in the red, with average category returns of -2%.

This is the worst performance of these two categories over the last 15 quarters for which data was analysed.

?A sharp rise in the 10-year government bond yields because of the global environment as well as domestic macro-economic factors resulted in long-duration bond funds underperforming other fixed-income categories during the quarter,? said Dwijendra Srivastava, head (fixed income), Sundaram MF.

Liquid funds emerged as the best performers during the quarter with average category returns of 2.25%, followed by ultra short-term bond funds with returns of 2%. The rise in yields has a minimal impact on schemes that invest in papers of short maturity, which is why returns of liquid and ultra short-term funds were not impacted as much in the quarter, said experts.

Ten-year government bond yields rose about 127 bps to 8.736% at the end of September from 7.463% at the end of June. ?What took the markets by surprise was the hike in marginal standing facility (MSF) rate in July and the surprise hike in repo rate in September,? said Srivastava.

Debt funds, especially long-tenure bond funds, faced the biggest setback in returns during the quarter on July 16 and September 20. On July 16, returns of some income and gilt medium-&-long-term debt funds declined 3-4% following a sharp spike in yields on the back of liquidity tighening measures introduced abruptly by the RBI. In July, yields on the benchmark 10-year bonds rose about 70 bps to 8.169% at the end of July from 7.463% a month ago.

On the other hand, absolute one-day returns of long-duration bond funds declined anywhere between 1.5% and 2.5% on September 20, as the new RBI governor surprised the market with repo rate hike. Yields of the benchmark 10-year bonds on the day rose 36 bps to 8.559% over the previous day.