Interest rate dynamics rattle debt investors

Sliding rates pose a threat to higher returns

Debt fund investors are in a dilemma as interest rates seem to have bottomed out. The bond market has seen interest rates dropping regularly in the three years from 2000 to 2002, thus allowing debt fund investors to generate returns through investment in long term bond funds and gilt funds.

However, the current low rates have given rise to fears about the potential of these funds to generate returns higher than conventional savings options.

But mutual funds such as Standard Chartered AMC are confident about producing higher returns than normal savings options such as deposits, provided investors invest in products such as dynamic bond funds.

Standard Chartered MF's has been propagating products such as dynamic bond funds and floating rate funds to stem the outflow of investors from income funds.

However, the fund's dynamic bond funds such as Grindlays dynamic bond fund and Grindlays super saver Income fund - medium term have been able to double their assets under management recently.

"At the moment we are propagating funds such as the floating rate fund, the cash fund and actively managed funds such as dynamic bond funds," says Rajiv Anand, head of investments, Standard Chartered MF.

These products, by their nature, allow fund managers to shift their portfolios dynamically, thus taking advantages of even small shifts in the interest rates of actively traded government securities to generate returns higher than normal products that mostly rely on interest rate income.

Dynamic bond funds have the ability to emulate a cash fund when interest rates are rising thereby preserving capital, while it can generate the attractive returns of an income fund when interest rates are declining.

It is thus ideal for investors who are on the look out for extra returns with no exposure to equities in an otherwise benign interest rate scenario.

"As far as dynamic bond funds are concerned we are running 70-75 per cent in cash and a small portion in gilts and the rest in short-term corporate bonds," says Anand.

The fund's duration can rapidly be moved from being in days or months or years. According to Anand, the response to the dynamic bond funds have been encouraging. "The inflows in to dynamic bond funds have gone up from Rs 600 crore to Rs 1,200 crore.