Debt fund managers now prefer shorter average duration

In a shift in trend, debt fund managers are now selecting shorter average duration in their funds’ portfolio.

This change was induced on the hope of a further rise in interest rates amid high inflation and the expectation of a similar or slight increase in government’s borrowing programme in the next fiscal.

The average duration is currently at 1.5 to 2 years in long-term funds compared with 5 to 6 years a couple of months ago. While it is at 9 months to 1 year for short-term debt funds compared with about 2 years earlier.

Duration is a measure of the sensitivity of the price of a fixed-income instrument to a change in interest rates. Duration is expressed in years.

“In our short-term funds, the average duration is 1 year and in long-term funds it is 1.5 years. We expect rates to harden further, due to which we are carrying a shorter duration,” said Maneesh Dangi, head of fixed income, Birla Sun Life Mutual Fund.

The shift was started by a few fund managers in December and by January others followed the trend, since a rate hike was certain due to December’s high inflation numbers. The whole price index (WPI) in December was 8.43% year-on-year compared with 7.48% a month ago.

“Starting January, we reduced the duration, because our view is that there are quite a few negative fundamentals that are developing, including high inflation,” said Suyash Choudhary, head of fixed income, IDFC Mutual Fund.  Choudhary prefers an average duration of 1.5 to 2 years for long-term funds and between 9 months to 1 year for short-term funds.

Fund managers are of the view that the inflation may not come down to the March 2011 forecast of 7% by the Reserve Bank of India (RBI), due to which one more rate hike is in the offing in the next mid-quarter review of monetary policy in March.

Besides this, in the Union Budget to be announced later this month, the expectation is that the government’s borrowing programme for the next fiscal will be either similar or larger than what it was in FY11. Due to this, the RBI is expected to front-load the gilt auctions, which would result in a larger supply of gilts in the first half of the fiscal, while the demand for it (gilts) may not be the same. Owing to these two factors bond yields may rise further, due to which fund managers will stick to shorter average duration.

“Shorter duration will prevail as long as inflation does not fall. Fund managers will wait for the budget to figure out their investment strategy,” said Arvind Chari, debt fund manager, Quantum Mutual Fund.