Depreciating rupee bites into returns of long-term debt Mutual funds

The rupee’s steep depreciation,coupled with substantial selling by overseas investors in the debt market,has impacted the returns of income and gilt medium-&-long-term funds in June.

Written by Ashley Coutinho | Mumbai | Published:July 3, 2013 2:40 am

The rupee’s steep depreciation,coupled with substantial selling by overseas investors in the debt market,has impacted the returns of income and gilt medium-&-long-term funds in June.


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Income and gilt medium-&-long-term funds gave average category returns of -0.47% and -0.78%,respectively,in June. This was chiefly due to the 20-bps rise in yields of 10-year government securities in the last one month from 7.24% to 7.44%.

The rise in yields,in turn,was driven by the rupee depreciation of more than 5% during the month and offloading of debt holdings by foreign institutional investors (FIIs) worth $5.3 billion,the most in a single month in at least 10 years,following the US Fed’s suggestion that it would pare down its quantitative

easing programme.

“The rupee’s depreciation,together with Fed chairman Ben Bernanke’s hawkish statement,took Indian fund managers by surprise. Those who did not cut their position in long-duration papers incurred more losses than others,” said Dwijendra Srivastava,head,fixed income,Sundaram MF.

He added that the spread in yields between government securities and corporate bonds had also widened from 70-75 bps to 80-85 bps in the last one month as the rate of rise in yields in corporate bonds had been higher than that for government securities.

Bond prices and yields share an inverse relationship; if yields rise,bond prices fall and vice versa. The fall in bond prices affects the net asset value of debt schemes,especially those that have a mandate to invest in longer-duration papers of between five and seven years,according to experts. The rise in yields,however,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 in June.

According to Killol Pandya,senior fund manager,debt,LIC Nomura MF,the gilt segment had seen a rally early June in anticipation of another rate cut from the RBI,which did not materialise. “The unreasonably bullish sentiment has become more realistic now,” he said. Expectations of further rate cuts from the RBI have dimmed due to the steep depreciation in the rupee,which is expected to add to imported inflation pressures and reduce room for rate cuts. The RBI has reduced key policy rates thrice by 0.25% each in calendar year 2013.

However,the RBI’s indication that further rate cuts would be dependent only on a durable reduction in inflation has led fund managers to expect yields to remain range bound in the short term. “The central bank continues to remain hawkish and there are no key drivers for the yields to either harden or come off in the immediate future. However,we do expect some bouts of volatility,” said Pandya.

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