Investments depend on liquidity needs and interest rate outlook

With debt being the flavour of the season, this week has seen launch of two debt mutual fund schemes. Birla Sun Life Mutual Fund is offering a short-term fixed maturity plan (FMP), while L&T Mutual Fund has launched a short-term debt fund.

L&T’s short-term debt fund is a three-year fund, benchmarked against Crisil’s short-term bond fund index. Birla’s fixed term plan, Series DV, is a close-ended income scheme, for a duration of 546 days or a year and a half.

Joseph Thomas, head- investment advisory and financial planning, Aditya Birla Money, says, “With inflationary expectations getting moderate and the resistance that short-term interest rates are facing, investing into short-term funds offer an appropriate risk-return trade off for investors.”

He advises, investors to go into schemes with a maturity profile of above six months to two years.

Though everyone agrees we may have reached the sharp end of the interest rate curve, it may still be some time before a reversal in trend. Which is why, depending on the investor’s liquidity needs and his view on interest rates, one could opt for either an FMP or a short-term debt fund.

According to Bekxy Kuriakose, senior fund manager, L&T Mutual Fund, “Investors who are fairly confident of rates having peaked out and have no urgent need of liquidity can lock in their money into short-term FMPs.”

FMPs invest in debt securities, that mature just before the scheme’s maturity. FMPs with over a year duration are popular because of the possible double indexation benefits.

For instance, if an investment is made in December 2011, one can claim indexation benefits for both financial years 2011-12 and 2012-13, as the product will mature in 2012.

With inflation at around nine per cent, a double indexation benefit (of 18 per cent) would make the investment tax-free. Those in the highest tax bracket will benefit the most.

On the other hand, those willing to take the interest rate risk but wanting to minimise their capital losses, can invest a small part of their portfolio into short-term debt funds.

“Unlike a gilt fund or a long-term bond fund, short-term funds should be giving positive returns and one can look at investing, say, between 20-30 per cent of their portfol-io into them,” says Dhurva Chatterji, senior research analyst, Morning Star.

In the event of interest rates beginning to reverse, short term debt funds will benefit and not FMPs. This is because with an FMP you are locked in with both the tenure and the interest rate, unlike a debt fund which is open-ended.

L&T’s scheme is an open ended scheme that gives the investor the freedom to exit when he wants.

In the last one year, short-term FMPS have given returns of 8.82 per cent and short-term debt funds 8.69 per cent.