The one-shot appreciation for bond funds on the back of a triple dose of rate cuts is over. With interest rates in the economy heading southwards, fund managers are now faced with the grim prospect of a drop in interest income from bonds. This, in turn, will lower the returns from debt-oriented mutual funds. Fund managers, in unison, opine that last year's performance will not be sustainable in the new financial year and see returns dropping by 100-150 basis points. The Value Research category of 34 medium-term debt funds has posted a return of 11.05% for the one-year ended March 31, 2001. The asset management companies also want investors to re-align their expectation in line with drop in interest rates elsewhere in the system.
"The target return really is variable, linked to the other rates of return in the system. For example, PPF used to give 11% earlier and now it is at 9.50%. This could not have happened in isolation and will bring down other rates of return including those on funds. Returns today, can be between 9-9.5% on a 1-year horizon on a debt fund. However, bond funds have become all the more attractive now for the kind of liquidity, tax incentives (lower distribution tax) and service standards they provide,'' says Binay Chandgothia, fund manager, IDBI Principal Mutual Fund. Adds Nilesh Shah, chief investment officer at Templeton, "Now the coupon will be on a lower side and our target return will be in the band of 8.5 to 9 per cent." The AMC's flagship bond fund, Templeton India Income posted a one-year return of 11.18% last fiscal.
While returns are bound to go down, fund managers are also not keen on assuming extra risk by diluting credit quality to match previous performance numbers though G-sec exposure could be increased, albeit within reasonable limit, depending on the interest rate outlook. Says Sandesh Kirkire at Kotak Mahindra AMC, "The current strategy of managing portfolio maturity through government securities with investments in medium-to-long gilts will continue. We will also maintain investments in short to medium corporate segment. However, we will stick to corporate quality with a strict no to lower rated bonds." Adds a fund manager at a leading AMC, "In a stable interest rate environment, one could moderately increase exposure to corporate bonds though a very aggressive exposure will be risky due to their relatively low liquidity. While taking exposures in quality AA papers could generate higher returns, there are limited quality opportunities there."
On the other hand, some bond investment strategists plan to pursue active trading to give an extra kicker to returns with focus on sovereign bonds, since they are the most liquid lot in the debt market. "It will be better to be cautious than aggressive though we shall be looking to trade across gilts and corporate assets on spreads. Further, we plan to concentrate upon interest rate cycle to take advantage of volatility,'' says Shah at Templeton. Adds Chandgothia "The sovereign exposure would have to be traded more actively than before as the one-way upward bias to prices seems to be over. Of course, since yields on sovereign have already declined considerably over the past 2-3 months, one would have to take a call on moving some assets to corporate bonds, which offer a higher yield by 100-120 basis points.''
While trading strategies and risk-bearing capabilities may differ, fund managers want investors not to expect the last year's returns, which were buoyed by such exceptional events like IMD inflows and four rate cuts (including the reduction on coupons of small saving instruments). "The positive for many of them will be the reduction in dividend tax which means that at the post tax level, there is unlikely to be much difference in the returns,'' says a fund manager. Adds Suresh Soni at Koathri Pioneer,'' We believe that investors should realign their portfolios in terms of reducing exposure to traditional saving instruments.''