Bond funds may take a big hit

The previous low in terms of 7-month return was 2.88 per cent in 2003 when such schemes gave an annual return of 7.7 per cent for the full year. Fund managers also admit that this year may prove to be the worst period for bond funds.

The hardening of global interest rates, inflation touching a peak of 7.51 per cent and international crude oil prices hitting a record high have kept the debt market on tenterhooks, building pressures on returns in bond funds.

Admitting that annual return could touch an historic low in 2004, Krishnamurthy Vijayan, chief executive of JM Mutual Fund said: 8216;8216;Now, the risk-reward is not in favour of bond funds.

That8217;s why we have been advising investors to move into floating rate funds.8217;8217; On a query whether bond funds would yield negative returns, Krishnamurthy ruled out the possibility and said: 8216;8216;Yields have substantially risen and I think, markets should stabilise going forward.8217;8217;

During the seven-month period January-July 2004, monthly return in bond funds was positive only on two occasions 8212; March 1.14 per cent and April 0.48 per cent.

Barring these two months, monthly returns in these schemes were negative up to 0.92 per cent.

In fact, these schemes have yielded negative return consecutively during the past three months.

Nevertheless, a piece of advise for bond fund investors came from Naval Bir Kumar, MD, Standard Chartered Mutual Fund: 8216;8216;Investment in bond funds should be done with at least a 3-year time horizon.

If a fund which currently has an average duration of 3 years and has an yield of 5.5 per cent, it would mean an investor should expect an annual return of 5-5.5 per cent for the three-year period.8217;8217;

However, Kumar admitted that if interest rates go up from current levels, the annual return could go down below 5 per cent.

He was quick to add that if rates rise, 8216;8216;return could also go up8217;8217;. 8216;8216;He could be a loser or gainer in that situation. Bond funds8217; return always reflect the interest rates prevailing in the economy. Over a longer duration, good return in a year averages out bad return in another year,8217;8217; Kumar said.