Your Bond Fund has dumped you in last two-three days. Don't press the panic button. With a one-year return of 13.73 percent, they are still very rosy.
14-Jul-2001 •News Desk
The uninterrupted surge in bond funds' net asset values finally came to a grinding halt this week. With the RBI deputy governor, Y V Reddy reportedly ruling out any interest rate cut, medium-term debt funds lost an average 5 paise of 0.25 per cent in the last two days as prices crashed on the Bond Street. On the other hand, the losses for long-term gilt funds were steeper at 0.74 per cent. Gilt funds, by virtue of their dedicated investments in long-term sovereign bonds, are more sensitive to risks in the market. Thus, with the average maturity for this category at 7.87 years on June 30, the sharp fall does not come as a surprise.
What Triggered the Fall?
Bond markets have been on fire since the beginning of the current calendar on the back of surfeit of liquidity and flurry of domestic and international rate cuts. Since prices and interest rates move in opposite direction, NAVs of debt funds were simply zooming with the six-month returns (as on June 30,2001) at a whopping 8.51 per cent. On the other hand, a slack economy and little credit demand from companies has ensured that debt market participants continue to invest in bonds without putting pressure on interest rates. The current rally was again built around the expectation of another rate cut as the economy has failed to rev up. While the RBI did reduce the key bank rate by 1%, the markets were hoping for further cuts to trigger growth and hence, bidding up bond prices. This had also pulled down the yields (which move inversely to prices) to historic lows.
However, the party came to an abrupt halt on Reddy's statement. He is reported to have said that there was not much scope for bringing down interest rates through an isolated signal like the bank rate. "If an impression has been given that interest rates will keep going down and down in order to just revive demand, it is a wrong signal,'' he elaborated. No wonder, the remarks provoked large-scale selling as the entire edifice of hopes for another rate cut collapsed.
The current gains in the debt markets were clearly unsustainable and the flow of abnormal returns had to stop. While there has been a panic reaction, prices are expected to stabilise soon with comfortable liquidity in the markets. The RBI's clarification that it was not averse to cutting interest rates would help soothe nerves.
Despite the blip, the long-term returns on bond funds are still very rosy. For instance, the one-year return on July 13 is at 13.73 per cent while the six-month return is 8.47 per cent. Those are certainly ballistic gains from bond funds by any stretch of imagination. Thus, investors would do well to stay invested and not redeem in panic. At the same time, a repeat of gains in recent months is unlikely and hence, investors should rein in their expectations. Yet, while returns may slow down, bond funds still hold promise to provide higher returns than other fixed income options. With high liquidity of course!