Your last chance to invest in debt

Why? The interest rate environment is taking a turn. After raising the policy rate by 375 basis points during March 2010 to October 2011 to contain inflation and anchor inflation expectations,the Reserve Bank paused in its mid-quarter review of December 2011. In January,the RBI cut cash reserve ratio (deposits that banks have to keep with the RBI) by 50 basis points (0.5 per cent) which helped inject liquidity into the system. In its annual policy statement this month, RBI announced a repo rate cut of 50 basis points. The availability of liquidity for banks at lower yields of 50 basis points post rate cut will bring down money market rates. Rates on three-month and one-year certificates of deposit will come off by 70-80 basis points from levels of 9.4 per cent and 9.9 per cent,respectively,say market players. Corporate bond yields at 9.4 per cent for five and ten-year AAAs are also expected to come off.

The apex bank provided further liquidity by raising the borrowing limit under the marginal standing facility from 1 to 2 per cent of commercial banks’ outstanding net demand and time liabilities. “In this scenario,short-term yields should remain stable in the next few months,” says Yadnesh Chavan of Mirae Asset Global Investments,India.

Investing In Debt

It’s not difficult to make money if one can understand volatility in any asset class by reading the trend and debt is not an exception. Bond prices and interest rates have an inverse relation. When interest rates fall,bond yields too fall and their prices increase. This leads to better returns whenever the interest rates are on downward spiral and gives investors an opportunity to tap short-term gains. Therefore those who locked-in money during the successive rate hikes are sitting on good returns now and can expect returns till the downward cycle continues.

The best opportunity to lock oneself in a debt product was till November-December last year as towards January,markets had already factored-in the rate cut. Looking at the inflation trends,among other factors,market insiders are not expecting a secular downtrend in the interest rates.

“Investors who are risk averse and have an investment horizon of one year should invest in short term bond fund as the margin of safety is higher in that segment. The risk-return profile favours investment in short term bond funds due to higher accrual and capital appreciation due to rate cut in the coming months. Investors in short-term bond fund can expect returns of 100 to 150 basis points over liquid fund over a one year time frame.

The returns of duration products would be about 200 to 300 basis points over the liquid fund returns over a one to two year time frame,” says Murthy Nagarajan of Tata Mutual Fund.

“Investing in dynamic bond funds can be a good option for investors as there is no clear trend emerging,” says Dhruva Chatterji of Morningstar India.

Dynamic Bond Funds

Dynamic Bond Funds provide flexibility to the fund manager to actively manage the duration of the fund according to the bond market and gain on that. A few of the dynamic bond funds like SBI Dynamic,IDFC Dynamic,Reliance Dynamic,and HDFC Medium Term Opportunities have seen their assets rising from a few crore rupees in June 2011 to R 400-500 crore in the March 2012 quarter. The largest dynamic bond fund Birla Sunlife Dynamic Bond Fund has seen its assets rise beyond the R 5,000 crore mark,and has risen 50 per cent in the past quarter.

The performance of dynamic bond funds has been good of late with many of them emerging as the top performers. “The good performance of these dynamic bond funds has been helped by the active duration management of these funds and their ability to quickly reposition their maturity profile to suit the changing interest rate environment,” said Chatterji.

Dynamic bond funds have cut their maturity profile,probably reacting to spike up in bond yields in March,post the budget. SBI Dynamic Bond fund,which increased its average maturity profile to excess of 8 years in Nov 2011,has now cut it to less than a year in March 2012. Similarly,Reliance Dynamic Bond fund which increased it average maturity to 11.5 years in Nov 2011 has now cut it to 3.73 years in March 2012. Along with Dynamic Bond Funds,Fixed Maturity Plans (FMPs) too present a good opportunity to lock-in money at better rates. “FMPs are a good option for stable returns.

Locking-in into the higher yields now will be prudent,” says Chatterji. As compared to fixed deposits (FDs),debt products make better sense for the fact that post tax returns on debt products comes to around 8 per cent as compared to 6.2 per cent post tax returns on a 9 per cent FD (for a 30 per cent tax bracket).

There might not be much time left to make money on debt products before the window gets closed. So hurry up if you are looking at investment options for 12 to 18 months.

—ritukant.ojha@expressindia.com