Ultra short-term funds may perform better in next six months

These funds offer investors greater protection against interest rate risks

Given the expected volatility in bond yields in the first half of 2015 (calendar year), ultra short-term funds are likely to perform better during the period than medium- to long-term gilt funds, which have given the highest returns in the debt funds category in 2014.

Ultra short-term funds invest in debt instruments of very short maturities. These funds offer investors greater protection against interest rate risk than longer-term bonds.

“In the initial part of the year, there will be a little bit of choppiness in long duration funds. There might be a bit of performance, but it will not be even... In shorter duration funds, investors will get less loss because of lesser volatility,” said Dwijendra Srivastava, chief investment officer (debt) at Sundaram Mutual Fund.

The volatility is attributed to the expected rate increases by the US Federal Reserve in the second half of 2015. Besides, there are concerns that the retail inflation for December 2014 might inch up with the base effect turning unfavourable. As a result, the rate cuts by the Reserve Bank of India might not start even in the next monetary policy scheduled on February 3.

According to data from Value Research, the category average return of gilt medium and long-term funds in 2014 was 16 per cent, while for ultra short-term funds it was nine per cent.

“Bond yields will be volatile, but if one could sail through this volatility, I would suggest duration funds. But if your investment horizons are short, then ultra short-term funds will be the best bet. The bond market will be choppy in the next few months,” said Lakshmi Iyer, chief investment officer (debt) and head of products at Kotak Mutual Fund.

According to the minutes of the US Federal Reserve's meeting held last month, there will be no interest rates increases before April. After the two-day policy meet in December 2014, the US Federal Reserve had said it could be “patient” in its approach to raising the benchmark lending rate from a range of zero to 0.25 per cent. However, it is believed that with each improving US economic data, rate rises are getting closer and 2015 will see the start of it.

Consumer Price Index (CPI)-based inflation data for December 2014 is expected next Monday. CPI inflation rose 4.38 per cent year-on-year in November 2014, the slowest pace in data going back to January 2012. The decline in inflation was due to cooling international oil prices, domestic prices of fruits and vegetable and a favourable base effect.