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Same Rate, Same State?

The average maturity on several debt funds has increased in anticipation of an interest rate cut…

The Reserve Bank of India’s (RBI’s) decision to hold the rate cuts leaves debt fund investors with more questions staring at them than simple answers. Most often, banks cut their lending and deposit rates simultaneously to adjust interest rate margins. And by now, readers of this magazine know that any fall in interest rates leads to increase in bond prices and lowering their yields. While, the overall mood amongst debt fund managers is sombre, they are positive about the imminent rate cut to start soon.

Amid high inflation, the RBI has retained the rates to curb the inflationary pressures. Moreover, the government spending has not yet taken off, which could ease the liquidity in the domestic market and result in a possible rate cut in the future. Many fund managers expect cut in rates in the future and have already started taking measures to gain from any such cut.

They have started increasing the average maturity and it is to avoid the interest rate risk in the short-term. Now they mostly hold debt instruments with maturity going up to 2 years and more from the prevalent 1 year or less. For instance, the biggest short-term income fund, Templeton India Short-term Income Retail, which manages Rs 5,200 crore, has debt papers with up to 2.25 years of maturity which is on the higher side after April 2008. Funds like HDFC Short-term, HSBC Income Short-term and SBI Short Horizon Debt Short Term Inst are all following a similar strategy.

Generally, investments in gilt funds, which invest in government securities (G-Secs) and investments in income funds, which invest in corporate bonds, could give higher returns as the interest rates decline, because their prices go up. Ten funds, managing more than Rs 100 crore from the universe of 117 schemes, have increased the maturity of their portfolio to the highest level in recent months. The biggest fund in this category, Birla Sun Life Government Securities Fund Long-term, which manages Rs 254 crore, has debt papers of more than 10 years maturity; on higher side after almost 4 years.

Funds accounting for 70 per cent of the assets of all the income funds (12 such funds among 102) have increased the maturity of their portfolio to the highest level in the last few months For instance, Templeton India Income Opportunities and Templeton India Corporate Bond Opportunities have debt papers of the highest maturity since their inception of 2.8 years to maturity, with BSL Dynamic Bond Retail, which manages Rs 12,125 crore, holding debt of 3.72 years to maturity which is highest in the past one year.

All these moves will help investors who will benefit from the inverse correlation between interest rates and debt fund yields.