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The party seems relentless

Even as the fall in interest rates has triggered this rally, the gains are largely one -time. Returns are now expected to settle lower in the long haul

The debt markets are on fire, rising by the minute after they recovered from a turbulent spell in October last year. If you are wondering what is driving the relentless party with lavish returns, the reasons are rather simple. The general trend since last year has been towards softening of interest rates. In recent times, lowering of interest rates on bank deposits followed a PPF rate cut. Last month saw another step towards reduction of short-term rates, with a cut in CRR and lowering of repo rate.

Bond prices move up in response to a lowering of interest rates, while shedding value when rates move up. With events in recent times pointing to a lower interest rate regime, bond funds have offered splendid returns. For instance, the simple return from medium-term debt funds in May was 1.73% or an annualised 20.80%.

However, the fall in interest rates that has triggered this rally is largely a one-time event. Thus, the gains are also one time and returns are now expected to settle lower in the long haul as interest income drops from debt instruments.

Debt with marginal equity
Popularly known as monthly income plans or MIPs, these funds hold enough potential to rock your boat with a 10-15% equity exposure. However, even as they add to risk, they can surely deliver in the long run. This category of 13 funds has posted an average gain of 1.60% in the last month. HDFC Children's Gift (Savings) tops its category with a gain of 2.60% with a pure debt portfolio.

Medium Term Funds
While bonds move up in time of a rally, the appreciation is sharper in case of funds with a longer maturity. Thus with the sentiment largely upbeat, bond funds have actively stretched their maturity to capture gains at the longer end of the yield curve.

Debt Funds
The 36-fund category of medium term debt funds posted an average gain of 1.73% during May. Grindlays Super Saver Income, despite a rapid growth in corpus to Rs 1024 crore in less than a year, has sustained active management to post a category topping return of 2.17% last month. HDFC Income Fund, which has had a similar growth trajectory with a corpus of Rs 1226 crore comes a close second at 2.10%.

Gilt Funds
These funds hold a mandate to invest in longer dated gilt instruments, and thus are best placed to gain in times of a rally. This category of 27 funds posted an average gain of 2.33% in the last month. Even as these gains look attractive, gilts funds fall in the high risk, high returns bracket in the bond league with their volatility and are unlike typical bond funds. K Gilt Serial 2013, with its long-term investment mandate tops the category with a gain of 3.64%.

Short term funds

Debt Funds
Short-term debt funds, the least risky among bond funds, are an ideal parking lot for your short-term surplus. With an annualised return of 9.44% in the last month, they are ideal substitutes for your bank deposits.

Gilt Funds
Short-term gilt funds, with their interest rate sensitivity (they are highly liquid instruments) can swing either way in the short term. Thus, the best hedge against volatility is to commit your investments in the fund for anywhere between 6 months to 1 year.

This category of 11 funds posted an average gain of 1.05%, with Birla Gilt Plus (Liquid) topping the group.