Mutual Gains

Investing in bond and gilt funds was the winning strategy last year, but this year it may be a loser's game.

These day's most investors think it's crazy to buy equity funds instead of gilt funds. Indeed, for the past two years, equity funds have been a sucker's bet, delivering an average negative return of 20.82 per cent annually compared with the beefy 16 per cent return for the bond funds.

Stock fund holders haven't just lost the tug of war with the bonds; they have eaten dust actually losing money for the whole of last year. Yet, we dare to say, year 2002 may well turn out to be the year of equity funds. Gilt funds will not be able to repeat their performance next year, while equity funds will rise from the ashes.

The past 18 months have been exceptionally good for gilt funds. But they won't sizzle this year. Further rallies are likely to be tempered as gilt prices are expected to stabilise and remain range bound in the medium term. Even more, the risk of interest rates rising back is not ruled out given the threat of war looming large.

In the past one year, yield on 10-year gilts have fallen from 12 per cent to less than 8 per cent, it is only obvious that they may not fall another 33 per cent in the next year unless Government decides to bring down rates on small savings schemes.

While there is only a limited scope for capital gains, returns could be dampened since fresh investments will be in lower-yielding instruments. Most fund managers contend that annual returns from bond funds this year will range between 8 per cent and 9 per cent.

However, there are still many unfathomables out there and any developments in the Indo-Pak situation and the likelihood of war could throw calculations awry. A growing fiscal deficit continues to be a cause for concern.

Given the sharp slippage in revenue collections and disinvestment proceeds, it is almost certain that the government will overshoot its borrowing target in the current fiscal. An increase in government borrowings could tighten liquidity, and in turn, put pressure on bond prices.

Given the tight leash on liquidity and the likelihood of interest rates declining further seeming bleak, it will be difficult for debt funds to replicate the performance of the past year.

On the contrary, equities will rise out of the current dumps. Even as uncertainty envelopes the equity markets, professionals feel we are very close to a bottom.

But keep your fingers crossed