The Reserve Bank of India finally cut benchmark interest rates rates on Thursday and hinted...
The Reserve Bank of India finally cut benchmark interest rates rates on Thursday and hinted at the start of a rate reduction cycle. Given the prospect of falling interest rates over the next 12-18 months, investors can look at income and long-to-medium term gilt schemes that might give strong returns in 2015, say experts.
Fund managers almost unanimously agree RBI may cut rates by a a further 75 basis points (100 basis points=1%) in the current calendar year which will translate into good returns on long term bond funds. “With fall in crude prices and inflation almost under control, It is likely that we can further expect 50-70 basis point cut in benchmark interest rates in 2015. Even the 10-year benchmark government securities (G-Sec) yields which are trading at around 7.70% may further come down to 7.20% in next the 6-9 months, giving huge advantage to long term bonds funds,” said Dwijendra Srivastava, CIO of debt at Sundaram Mutual Fund.
The prices of fixed income securities are governed by interest rates prevailing in the markets. Interest rates and price of fixed income securities are inversely proportional. When interest rates decline, the prices of fixed income securities increase. Similarly, when there is hike in interest rates, the prices of fixed income securities come down.
Income and gilt schemes invest in long term papers of government and corporates and have higher maturity than medium term bond funds. So they are best suited for a falling interest rate scenario. Rahul Goswami, CIO of fixed income at ICICI Prudential MF said, “We see fundamentals improving over a period of time and have no concerns on current account deficit (CAD). In such an environment we recommend that investors look at medium to long term maturity fund because if there is a further fall in interest rates, bond prices will move up thereby ensuring capital appreciation for investors. We expect rates to gradually decrease over time”
In the last six months, the 10-year G-Sec yields has moved down from 8.5-8.6%. The sharp correction was backed by increasing expectations of a turn-around in the interest rate cycle. Not surprisingly, several funds which had increased their average maturity had benefitted in the past few months. However market participants also caution against rushing intolong term debt funds. Such funds are directly aligned with benchmark interest rates and investors may witness significant volatility given the duration of the products.
“Timing is very important in the long term bonds funds. While one might enter at the right time, even a timely exit remains a very important factor,” concludes a fund manager on condition of anonymity.