Rate hike to keep short-term debt funds in demand in near future

Written by Ashley Coutinho | Ashley Coutinho | Mumbai | Updated: Jan 30 2014, 06:39am hrs
RajanLong-tenure bond funds were only marginally impacted by the rate hike on Tuesday. PTI
With the RBI deciding to hike the repo rate by 25 bps on Tuesday, debt fund managers are advising investors to stick to short-term debt funds in the coming weeks.

Fund managers are advising investors to stick to liquid, liquid-plus, ultra short-term and short term income funds considering the uncertainty prevalent in the fixed-income market.

The current rate hike, together with the tight liquidity condition prevailing since mid-December, provides scope for investors to lock in to attractive short-term rates, said Vidya Bala, head, mutual funds research, FundsIndia.com, adding that higher demand for liquidity closer to the fiscal year end is likely to keep short-term rates elevated..

While the policy statement indicates that further tightening might not take place if inflation data come in line with expectations, debt fund managers believe that there is suppressed inflation in the economy as fuel prices in India are still not fully aligned to the global price movement. According to Bala, the data on inflation as well as the currency crisis and the slowdown in China may keep the market on tenterhooks in the coming weeks. On Tuesday, the 10-year gilt, rupee and Nifty all fell immediately after the policy, but recovered on guidance that further tightening is not expected at this juncture. The 10-year gilt stood at 8.71% pre-policy statement, rose to 8.8% post policy and ended at 8.74-8.76% levels.

Long-tenure bond funds were only marginally impacted by the rate hike on Tuesday. Fund managers believe only those with a long-term horizon of between 18 and 24 months should invest in these funds. We continue to believe that accrual-focused funds can help investors navigate the current uncertain environment. Investors with higher risk appetite and longer-term horizon can look at long-dated/gilt-focused funds, said Santosh Kamath, CIO, fixed income, Franklin Templeton Investments India.

Experts advise conservative investors to look at fixed-maturity plans (FMPs) as one-year CD rates remain attractive at over 9.5%. Investors can consider locking into these rates through one-year-plus FMPs if they are conservative. Investing at this juncture would provide double-indexation benefits as well. Others not wanting to lock-in their money can consider short-term debt funds with a similar time-frame and enjoy the same indexation benefit, said Bala.

FMPs of over a year attract 10% capital gains tax without indexation or 20% capital gains tax with indexation. The double-indexation benefit helps significantly lower the tax liability of the investor.