Short-term funds to come into limelight

Long-term debt funds have enjoyed a good run in the past year. Gilt medium and long-term and gilt short-term funds have been the category toppers. Dynamic bond funds - which move across durations - have given a return of 8.7 per cent, while income funds have delivered 8.6 per cent.

"There has been a broad market rally, which has contributed to the performance of long-term funds," says R Sivakumar, head of fixed income at Axis Mutual Fund. Yields of 10-year government bonds fell from 7.73 per cent a year ago to 7.49 per cent.

However, going ahead, market experts expect shorter tenure funds to new see better returns. "Short-term funds are likely to outperform from here on, as the Reserve Bank of India (RBI) seems to have come close to the end of the rate cycle and the scope for future rate cuts has substantially reduced. Assuming inflation can soften, we may at best see one or two 25-bps rate cuts over the next 12 months," says Sivakumar.

Experts expect yields of 10-year government securities to stay between 7.4 and 7.7 per cent over the next 6-12 months, depending on inflationary expectations. Among other factors that will have a bearing on domestic bond yields include rate action by the US Federal Reserve, crude oil prices and the inflation trajectory in India. "We advise investors to cut their duration and move into short-term bond funds, as the prospects of a rate cut are very low over the next six months at least," added Manoj Nagpal, chief executive officer of Outlook Asia Capital.

Returns across debt categories in the past two-three years seem to have converged because of the erratic movement in bond yields, say experts. "Long-term bond funds, despite the duration risk, have not been able to generate significant alpha," says Nagpal. Investors should play it safe and invest in short-term funds, while using duration funds for tactical play.