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Income Fund Worries

In August 2003, I had invested Rs 5 lakh each in two income funds. The returns on these funds have been very low. Should I switch to floating rate funds or continue in the same schemes for some time?

In August 2003, I had invested Rs 5 lakh each in Prudential ICICI Income Plan and Birla Income Plus (both in growth option) out of my VRS proceeds. The returns during the past one-year came down to around 2 per cent. What should I do? Should I switch to floating rate funds or continue in the same schemes for some time?

Joseph Fernandes

We have received many such queries from the worried income fund investors. Though we have addressed most of them at regular intervals, still we will address your question briefly here.

For the three straight years, we have seen a continuous fall in the interest rate. This helped all debt fund categories to post double digit returns till 2002. But the time has changed. The yield on the ten-year benchmark bond has risen sharply resulting in losses for the bond fund investors. A rise in inflation and the hike in global interest rates are the key factor pushing bond yields up (and bond prices down). This has also raised hope of a rise in domestic interest rate resulting in rampant increase in debt market volatility. Going ahead, we think this volatility would continue to prevail in the short to medium-term.

Thus, for an income fund investor, it's a high time to decide on what you want from your investment and how long is your investment horizon. If liquidity is not an issue, shift some money to guaranteed fixed-income products like RBI savings bonds and various post office schemes. The rate of interest is relatively good here (8 per cent). But the only catch with them is lock-in of over five years in each.

If you need money in the year's time, switching majority of your investments to floating rate funds or short-term funds won't be a bad idea. Floating rate funds hold up well when rates rise because they invest a majority of their assets in floating rate bonds. These funds are the ideal investment for the volatile times as of today. In the first seven months of 2004, these funds have delivered an average 0.36 per cent return (annualised 4.38 per cent). And as shot-term funds invest in low maturity instruments, the risk is low but the returns are also less here. In the year-to-date through August 17, short-term funds are up 2.3 per cent (annualised 4 per cent).

By doing so, your investment will be protected in case interest rates rises. And you can re-enter income funds once rates have stabilised at the higher level.

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