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Sizzling Bond Fund Returns: A Sudden Demise

Once again the funds of the week were-: US'64 and of course the rally in Bond Funds which came to a standstill with a rate cut expectation dying out.

Unit Scheme '64:
This week real small investors will get an opportunity to exit Unit Scheme '64. And it is likely that the government bailout being talked about will be bailout of the small investor at the cost of large investors in the fund. This will present an opportunity for small investors to redeem their units, but it will be at the cost of remaining investors which is highly inequitable and belies the mutual fund concept, as the relative benefit to investors will be disproportionate.

Bonds Losing Steam
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 as Gilt funds are more sensitive to risks in the market by virtue of their dedicated investments in long-term sovereign bonds. 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. Since prices of debt instruments and interest rates move in opposite direction, the flurry of domestic and international rate cuts caused the NAVs of debt funds to zoom with the six-month (June-ending) returns at a whopping 8.51 per cent. On the other hand, a slack economy and little credit demand from companies ensured that debt market participants continue to invest in bonds without putting pressure on interest rates. However, with the economy failing to rev up, the markets were expecting another round of rate cut hoping it would trigger growth in the economy and hence, bidding up bond prices. What resulted was an extended rally in the markets that pulled down the yields of bonds (which move inversely to prices) to historic lows.

Stay Invested
However, the party came to an abrupt halt on Reddy's statement 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. The remarks provoked large-scale selling as the entire edifice of hopes for another rate cut collapsed.

The high blown gains in the debt markets so far, were clearly unsustainable and the flow of abnormal returns had to stop. While currently the markets are panic stricken, prices are expected to stabilise soon with comfortable liquidity in the markets and RBI's clarification that it is not averse to cutting interest rates would help soothe nerves. Thus, investors would do well to stay invested and not redeem in panic. At the same time, a repeat of gains of 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!

Fund Update:
For the week ending July 13, 2001, the markets gained 148 points (4.48%) on the Sensex and 62 points (4%) on BSE National Index. The biggest gainers were Magnum Multiplier Plus (6.85%), IL&FS eCOM (6.05%) and JM Basic (5.86%). The sole loser was Taurus Discovery Stock (-0.05%).