Debt funds remain good bets

May pip equity yet again in 2017; managers recommend funds focused on short-term bonds

Investors in debt mutual funds (MFs) have been a happy lot with the segment having outperformed equities for two straight years.
 
While the benchmark Sensex has remained flat over a two-year period, fixed income funds have generated annualised returns in excess of 10 per cent over the same time. With the government keeping a tight leash on spending in the Union Budget and hopes of rate cuts from the Reserve Bank of India (RBI), debt funds could again outperform equities in 2017, feel experts.
 
Although returns of debt mutual funds (MFs) may not match those of the last two years, fund managers say investors can expect high single-digit returns in certain categories. Brokerages, especially foreign ones, are projecting single-digit returns for the equity market, too, in 2017.
 

Even though yields on government securities (gilts) have come down sharply in the previous year, experts believe there could be room for further softening in shorter-tenure bonds. When bond yields fall, bond prices move up leading to higher asset values for debt funds, and vice-a-versa. Debt MFs focused on corporate debt funds, duration bond funds and ultra-short-term debt funds could outperform, say fund managers.
 
“Long duration funds along with gilt funds should be in a position to post capital gains in 2017. Corporate debt funds should also reap the benefits of credit rating upgrades and credit spread contraction under the load of surplus liquidity, lower borrowing cost and pickup in consumer demand,” says Sujoy Das, head of fixed income at Invesco Mutual Fund.
 
The yield on the benchmark 10-year gilt has come off from last year’s high of 7.87 per cent to around 6.41 per cent now, before seeing a low of 6.19 per cent on 24 November, 2016.
 
“Although gilt yields have declined significantly in the last few months, we believe that a slowdown in growth, benign inflation and lower government borrowing could provide some headroom to RBI for one interest rate cut. Hence, investors who can withstand volatility could consider duration gilt funds,” says Franklin Templeton MF in a note.
 
Thanks to fiscal consolidation, the RBI could cut rates by 25 basis points (a basis point is a hundredth of a percentage point) at its policy meeting on February 8 and follow it up with more rate cuts during the course of the year.
 
“The net borrowing levels are largely contained and liquidity will also gradually find its way back into the banking system. All these are significant markers for improved interest rate conditions and the RBI may find headroom to deliver a 25-50 basis points rate cut,” says Lakshmi Iyer, chief investment officer, fixed income, Kotak MF.
 
However, some see risks to rate cut forecasts by the RBI. “With oil on the climb, pressures from higher government wages, and (US) Fed rates expected to rise, the space for rate cuts is dwindling. We expect one final 25 basis point rate cut in the cycle,” says Pranjul Bhandari, chief economist, HSBC India.
 
Iyer adds an array of domestic and international political events may keep the debt market uncertain this year.