Earlier in the week, the Reserve Bank reduced the bank rate for the third time in the current calendar by half a percent to 6.5 per cent, the lowest ever since May 1973. The cash reserve ratio was also reduced 2 percent to 5.5 per cent, adding Rs 6000 crore as additional liquidity in the financial system.
This has a bearing on your fixed income return from your bank deposits and returns from bond as well as gilt funds. In the immediate term, it translates into a one-time gain for the bond and gilt funds. In fact, gilt funds gained between 0.5 to 1 per cent in few days of rate cut.
With the cut in bank rate, banks are likely to reduce their deposit and lending rates. And the long-term implication is lower return from your fixed income investments. The return on bond and gilt fund will also come down. The consensus return estimate from a bond fund is in the region of 8 to 10 per cent in the coming year with greater stability. This could be very disappointing for investors who got substantially higher return from these funds till now. The average debt fund delivered 16 per cent return and the average gilt fund delivered still higher return of 22.5 per cent over the past 1-year ending Oct. 25, 2001. These returns were greatly boosted by the successive interest rate cuts. Investors are left with few options but to realign and lower expectations from the fixed income alternatives. Despite the falling returns, funds retain their relative attractiveness, as they will combine little higher returns with high liquidity and tax efficiency. Investors heavily dependent on regular income from their investment will have to assume little risk to combat inflation and preserve their capital's worth over time. Besides a large allocation, say 90 per cent should still be invested in a bond or a gilt fund and a small but long-term allocation to equities through a well-diversified equity portfolio can be an effective mean to the end.
Fund Update: For the week ended October 25, 2001, the markets gained mere 6 points on both the BSE Sensex as well as Nifty. The top gainers for the week were – DSP Merrill Lynch Opportunities (5.44%), Libra Taxshield '96 (5.07%), UTI Software (5.05%) and Magnum Taxgain (5%). The only loser during the week was JM Basic which lost 6.78 per cent.