Debt market: Tailwinds are at least a year away

Lower interest rates, when they come, are expected to boost bonds

Those looking for exceptional returns from debt funds may as well have a longer time horizon.

Lower interest rates, to boost capital gains, are at least a year away, said experts.

Rahul Goswami, chief investment officer (CIO), fixed income, ICICI Prudential Asset Management Company, said, "We believe interest rates will be much lower from their current levels over two years on the downward-looking inflation trajectory. With inflation likely contained, there is no reason for yields to remain elevated for a longer period. We expect the 10-year benchmark yield to be lower by 150 basis points (bps) from current levels by the second quarter of 2016."

Dwijendra Srivastava, CIO, fixed income, Sundaram Mutual Fund, said returns could go up significantly for those who can hold on for two years.

OUTLOOK FOR NEXT YEAR

• Liquid funds will give returns of over 50-75 basis points
• Duration funds will give good returns over the next two to three years as the RBI cuts rates
• Those with maturing FMPs should look to rollover if they don't need the money immediately, as otherwise tax changes will cut returns

"Assuming an investor has an appetite for intermittent volatility, duration funds have the potential to deliver superior returns over 18 to 24 months as the 10-year benchmark is 100 bps over 10 years' average," he said.

He added that liquid and liquid-plus funds can give returns which are 50 to 75 basis points higher than the repo rate. The repo rate is that at which banks borrow from the Reserve Bank of India (RBI) to meet a shortfall in funds. It is currently at eight per cent. Money market funds invest in short-term debt instruments that mature (or pay off the principal) in a year.

Duration funds invest in debt securities like corporate bonds and government paper whose maturity can be five to ten years. They are likely to give returns in high single digits, he said.

Government securities may be a good bet, said Sanjay Kumar, head of investment, PNB MetLife Insurance.

"On the technical front, the spread of government securities versus corporate bonds is quite fine, which further makes government securities more attractive. We expect the prevailing yield on the benchmark 10-year government security to ease. This means return from capital appreciation in addition to coupon income," he said.

The longer-term trend for fixed-income instruments is positive, according to Akhil Mittal, senior fund manager, fixed income, Tata Mutual Fund.

"With the RBI committed to fight inflation, and with the fiscal consolidation path being followed by the government, we feel inflation would start trending down over one-two years. The RBI would be in a position to cut rates as inflation comes within target glide path over a medium term. This would mean the fixed-income market would perform well over two-three years," he said. Investors in fixed maturity plans whose schemes are set to expire should look at rolling over their investments if possible, in the light of the recent tax change by which a higher tax rate will apply for investments less than three years.

"We believe investors who do not have liquidity issues should invest for three years," said Srivastava.