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Gilt funds recover partially with rate cut

Its just what the doctor ordered! The rate cut came in time for debt funds as a jittery market started to pull down the NAVs. Yet, it would be a while before losses are fully recouped.

Most gilt funds ended last week on a negative note despite a 50 basis point cut in bank rate and cash reserve ratio. While fund managers blame it on sharp losses incurred earlier in the week, few gilt and bond funds even got bruised on the day of the rate cut, though for a different reason. A stray deal in a sovereign bond hit their portfolio values. For instance, the provident fund option of Zurich India Sovereign Gilt lost 0.42% on Friday while the growth option of Magnum Gilt (long-term) lost 0.22%.

"The 11% 2006 government security is one of the top holdings of the PF plan. A stray deal in the bond, stuck before the rate cut, was reported on Friday. The deal price of Rs 104.05 appeared as the last traded price on the WDM segment of NSE even though the day's price was in the band of Rs 104.80-85. This led to a loss of around 80 paise and pulled down the NAV,'' said Sridhar Narayan, fund manager, Zurich India Mutual Fund. Ditto for the AMC's High Interest Fund, whose NAV remained static at Rs 15.77. The bond accounts for 5.57% of Magnum Gilt's Portfolio while it is the top gilt exposure in KP Income Builder's portfolio. The latter's NAV also did not budge from its Thursday's level of Rs 15.75.

However, the losses or the lack of movement should not worry investors. The NAVs are now expected to move up sharply, once the latest price is reflected in the valuations. "The NAV will gain handsomely since the 11% 2006 paper has further gained from its actual price last week,'' says Narayan.

On the other hand, most gilt funds and a few bond funds were still in the negative territory for the week with the rate cut failing to erase losses. For instance, the Value Research category of long-term gilt funds was down an average 0.19% for the week ended February 16. On the other hand, medium-term bond funds were up 0.14% with the pseudo-debt fund, PNB Debt losing 0.16% despite a gaining 0.24% on Friday. The fund has 80% of its corpus in 3 government papers.

"The losses from Monday through Thursday last week have not been completely negated. For instance, the loss on long-dated papers was around Rs 1.5 but on Friday, these bonds could move up only by 90 paise,'' says Nilesh Shah, chief investment officer, Templeton India Mutual Fund. "The mood was bit bearish initially with the cut not meeting market's expectation. At the same time, it has been a rare occasion when a reduction came before budget. The market expects another cut immediately after budget or in early April. With a firm trend, the last week's losses would be wiped off very soon,'' adds Shailendra Jhingan at Birla Sunlife Mutual Fund.

The interest rates are now south bound and investors can look favourably at bond funds but with a long-term perspective for stable returns. With the markets expecting an easy sail in the near future, any mild aberration can rock the sentiment and pull down your fund's NAV. Besides, markets could see heightened volatility as the guessing game on the quantum and timing of the next rate cut takes place.

Despite high-pitched volatility in 2000, debt funds delivered an average 11% return for the one-year ended January 31, 2001. It is a good 250 basis points more than a return of 8.5% on one-year SBI Bank deposit. With reduction in PLRs and a cut expected on small saving instruments, banks will be under pressure to cut deposit rates. This will make open-end bond funds more attractive since they supplement their interest income with trading profits.