Move to shorter-duration debt funds

Frequency, magnitude of rate cuts will be slow, going forward. Investors should be happy with lower returns

While there are expectations of further rate cuts in the future, investors should start moving their debt investments to funds that maintain an average portfolio maturity of less than four-five years. “We are nearing the end of the downward interest rate cycle. Longer term funds won’t be as attractive as they have been until now,” says R Sivakumar, head of fixed income at Axis Mutual Fund.

While the Reserve Bank of India kept rates unchanged on Tuesday, it has already cut rates by 150 basis points (bps) since 2015. Fund managers say while rates might come down further, they would not be of the same magnitude. Fund managers have started reducing the maturity of their portfolio. In its Dynamic Bond Fund, Axis Mutual Fund has brought average portfolio maturity to four-and-a-half years from seven years three-four months ago.

Following the last monetary policy in April, money managers were advising investors to opt for longer tenure gilt funds, which were paying handsomely for some time. The average returns from medium-and-long term gilt funds stand at 12.32 per cent for a year and 5.07 per cent for the past three months, beating all other debt fund categories. Wealth managers believe these will not be sustainable.

“Investors should lower their returns’ expectations. If they are able to make eight per cent returns net of expense, they should be happy. They should not get adventurous to play the little steam left in gilt funds and it’s risky,” says Sriram Iyer, CEO, Religare Wealth Management.

The best strategy is to let the fund manager make an interest rate call for you. That’s why Sunil Sharma, chief investment officer at Sanctum Wealth Management, suggests that investors look at dynamic bond funds and accrual funds. “While we are in a declining interest rate environment, there’s still risk of rising inflation fuelled by the Seventh Pay Commission. In dynamic funds, the fund manager changes the portfolio factoring in the interest rate scenario,” says Sharma.

Sharma says investors should keep a three-year horizon for these investments. An investor needs to pay short-term capital gains tax based on their slab rate if they redeem investments before three years. After three years, the tax liability reduces as investors get to use the inflation indexation benefit.

While going for accrual funds, opt for the ones with AAA-rated corporate papers. Wealth managers say there have been more corporate downgrades than upgrades. If an investor opts for a fund that has AA- or A-rated papers, the returns can get hamper.

Those with an investment horizon of six months to three years should look at liquid-plus funds, says Pankaj Sharma, head of fixed income at DSP BlackRock Mutual Fund. “Interest rates on bank fixed deposits and small savings schemes are bound to fall further. These funds can help investors get better post tax returns,” says Sharma.

Investors having investment horizon of a year or more can seek investment in a short-term fund or an income opportunities fund, advises Pankaj Sharma, head of fixed income at DSP BlackRock Mutual Fund. “With the general decline in the term structure of interest rates, traditional savings instruments like fixed deposits and other small savings instruments may deliver lower returns. These funds can help investors get better post-tax returns.”

There are a few funds which recently started investing in long-term papers issued by different states in India, called State Development Loans. “The softening of yields has not happened in such papers and they have the potential to give higher returns,” says Iyer.