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One-Year Returns in 8-10% Band, Concur Fund Managers

While fund managers expect interest rates to remain soft, they see the rally in the bond markets tapering off. Yields on the benchmark ten-year paper are now expected to move in a narrow range

The rate cut may have buoyed the net asset values of bond and gilt funds in the short-term but the long-term implications of lower interest rates has got investors worried. Fixed income investors see their investment avenues shrinking as returns take a knock. And after asking the government to reduce administered rates on small saving schemes, the RBI has now politely directed the banks to introduce a flexible interest rate structure on deposits. While a variable scenario means that returns on saving schemes and deposits can also go up, the current era of softening interest rates is the source of anxiety.

Value Research spoke to leading fund managers on the impact of the credit policy on returns from bond funds and the risks that could mar the bullish sentiment in the markets.

Shailendra Jhingan, Birla Sun Life Mutual Fund

On Outlook
Outlook for the next few months is stable. But ultimately the pressure could come in the last quarter as a result of the pressure on BOP and the rupee (mentioned in point 4.). But we cannot expect the 10-year yield to rise beyond 9.25%.

On the Current Rally
The rally will now get capped, as the RBI would not allow the rates to come down too much. We could see auctions and OMO sales around the time of the inflow. Clearly the policy mentions a lot of structural issues that will not allow the yields to come down beyond a certain level. I would presume that the 10-year yield could touch 8.9% once but will not sustain at these levels.

On Returns from bond Funds
The returns in the bond funds won't change substantially as the event has resulted in just 10-15bps downward movement in interest rates across the medium - long end of the corporate yield curve. The same return expectation of 8-8.25% are intact.

On Risks
Any pressure on rupee in the last quarter due to pick up in demand could skew the trade balance as the imports will pick up and exports will continue to de-grow in an environment of global slowdown. Also, there should be a marginal pick up in credit offtake as the demand picks up. However, we do not expect a sharp rise in yields as both RBI and government is keen to see that interest rates remain soft. Therefore, we see a 9.25% yield target for the 10- year paper by March end.

Ramgopal Kundurthi, IL&FS Mutual Fund
On Outlook
I see the interest rates stable to lower with a medium term target of 8.75% on the 10- year sovereign bond.

On the Current Rally
Even though bond markets have rallied significantly over last few months, the corrections of August and September have been decent. Hence, I don't see a major problem in the continuation of the rally, but with periodic corrections.

On Returns from bond Funds
Gross running yields on bond funds should be around 9% assuming stable conditions and no rate hikes. In case of rate cuts and further market rallies, a capital appreciation of an additional 1 per cent could be possible.

On Risks
The risks in the short-term are (a) external and political events. In the medium term: (a) improvement in economic activity, credit-off take and inflation and (b) large fiscal deficit. In my view, fiscal deficit represents the biggest risk for bonds and any major reversal on this front would be promptly "priced in" by the markets. There was a press report that the Parliamentary Committee constituted to consider the draft Fiscal Responsibility Act has removed some of the restrictive provisions on the Central Government. This is not a good sign. In my view, the longer-term health of the bond markets would depend a lot on how this FRA is operationalised and how much of the earlier promises (see last budget) will be translated into action.

Suresh Soni, ITI Pioneer Mutual Fund

On Outlook
RBI has given out a decisive signal and the debt markets have reacted positively. The yields on gilts have softened by around 25 basis points so far. The liquidity infusion due to these cuts should result in the debt markets being comfortable in the coming months and the low interest rate scenario should prevail. With the bulk of govt. borrowing been completed and a poor offtake of credit, the low interest rate regime should continue in the future also.

On the Current Rally
Going ahead, we expect bond prices to stay firm, but it is unlikely that the aggressive rally witnessed in the past will be repeated.

On Returns from bond Funds
From current levels, the one-year target return should be in the range of 8-10% if the market conditions remain the same. Debt fund investors should consider anything more than a single digit return for one year exceptional.

On Risks
We do not foresee any major factors, which can mar the sentiment in the bond markets. But, event risk is something unpredictable. However, the two main factors, which could have an effect are – Oil prices: While global oil prices continue to rule low currently, in the case of the conflict in Afghanistan escalating, any significant rise in oil prices could affect the sentiment. Fiscal Deficit: While the markets are reconciled to an overshooting of the government borrowing programme, if the numbers for fiscal deficit are worse than expectations, the markets could react negatively.

Sandesh Kirkire, Kotak Mahindra Mutual Fund

On Outlook
The RBI has flooded the market with liquidity. The interest rates would remain stable and range bound. I do not see any signs of hardening. We believe that the RBI has reached at the end of the road. They have in fact indicated that they can do only so much. The interest rates or the lending rates can come down only when the deposit rates are reduced. However, these can not be reduced significantly any further till the administered rates are dropped further.

On the Current Rally
The bond rally would continue for some time but I feel that the 10-year could trade in 8.75 to 9% range. The market should consolidate these gains in the next few days.

On Returns from bond Funds
We continue to hold our view of 8-10% return in K-Bond and K-Gilt for a 1-year horizon. This is assuming no further rate cuts and the interest rates remaining range bound.

On Risks
The factors that can mar sentiments are mainly arising out of the event risk (read Afghanistan). It could affect oil prices, then the rupee markets and then the bond markets. In case the RBI wants to temper the rally, it could introduce an OMO. However this may not happen immediately. I think the RBI would try to maintain a positive sentiment for the time being. We would also need to look at how the nationalised banks react on the deposit rate cut or the PLR front.

Pijush K Das, SBI Mutual Fund

On Outlook
Outlook is positive. During the course of this year, I see cut in repo rates, possible cut in small savings rate, RBI relief bond rates, Employee Provident Fund rates etc. I will go with the RBI governor's softer interest bias.

On the Current Rally
As of now, yes, I see the rally sustaining. Normally investment led downturn takes some time to rebound. Credit offtake will continue to be poor and the market will see an uptrend on expectations on interest rate cuts.

On Returns from bond Funds
If there are no cuts and no expectations of a cut, I see one year return at around 8 per cent from now.

On Risks
Factors that can mar bond market rally - Kargil type war. Change in government, financial sector disequilibrium, non-financial sector events, massive overshoot in government borrowings, massive deficit in the fiscal, low tax collections etc.

Nilesh Shah, Templeton Mutual Fund

On Outlook
Now we see stable interest rates with no more rate cut by the RBI. The 10-year paper will be in the range of 8.75 % to 9.00 %.

On the Current Rally
This is the end of the bull-run in the debt market.

On Returns from bond Funds
Returns will be in the range of approximately 7.00-8.00 %.

On Risks
USA attacks on Afghanistan. One more WTC kind of attack. FII selling in Hordes. Sudden pickup in credit along with government borrowing.