Investors prefer bank fixed deposits to income funds

There is a saying, ‘all that glitters is not gold’ and this is true in the case of income funds in the current fiscal. The net inflows on a year-on-year basis in February grew by 180% at Rs13,708 crore.

The Association of Mutual Funds in India (Amfi) data shows that in the first eleven months of FY11, the industry had witnessed net outflows to the tune of Rs6,094 crore compared with net inflows of Rs2,61,065 crore in the first eleven months of FY10.

Rising interest rates was the key factor for such heavy outflows. Income funds invest their corpus in gilts, corporate bonds and even short-term papers.

They are not a good bet in a rising interest rates’ scenario because prices of gilts and corporate bonds fall with interest rate hikes.

“When interest rates rise, people move out of income funds and that has been the case with investors due to which there are net outflows in FY11,” agrees the CEO of a fund house who did not wish to be named.

In April the repo rate and the reverse repo rate was 5% and 3.50% respectively. At present, the repo rate is at 6.50% and the reverse repo rate is at 5.50%. The Reserve Bank of India (RBI) resorted to a hawkish stance to contain inflation.

Investors preferred parking their funds in fixed deposits (FD) at banks as that was an attractive option available to them. “More than redemptions from income funds, fresh money didn’t come in due to higher bank FD rates,” said Rajan Krishnan, chief executive officer, Baroda Pioneer Mutual Fund. In FY11, on an average, bank deposit rates moved up by over 200 basis points.

According to Value Research Online, in the last one year, income funds generated a category average return of 5.36%. On the other hand, a one year and one day bank FD fetches the customer a return of over 8%.

The situation may not change till March. This is because bank FD rates are expected to inch up by another 25 basis points before the current fiscal ends.

“We may see another hike in deposit rates by 25 basis points this month. This will be the peak for deposit rates. I do not see more hikes in the new fiscal,” said Suresh Ganapathy, head of financial research team, Macquarie Securities.

This is because in the new fiscal liquidity conditions will ease. Demand for resources will be less because credit growth will also come down.

Due to that, despite more hikes in key policy rates by the RBI, banks will not increase deposit rates further, Ganapathy said.

As a result, fund houses expect some respite in FY12. “I don’t think the trend of rising deposit rates will continue, as banks may issue fresh FD rates in April. Hence the situation may stabilise by April,” said Deepak Chaterjee, managing director of SBI Mutual Fund.

Nandkumar Surti, chief investment officer, JP Morgan Mutual Fund, concurs, “Money is expected to come back into the system after April.”