Short-term funds may gain on rise in interest rates

Short-term debt funds will continue to be among the most-sought after in 2011 as returns are expected to improve 100-150 basis points (bps) with interest rates seen rising.

Inflationary pressures may lead the Reserve Bank of India (RBI) to hike benchmark rates 75-100 bps, said fund managers.
On the other hand, long-term funds will suffer as the rise in yields will impact returns adversely and dent inflows.

“The RBI would carry its anti-inflationary stance regarding the monetary policy in 2011, and repo and reverse repo rates are likely to be increased by 75-100 bps, “ said Rahul Pal, head-fixed income, Taurus Mutual Fund.

The RBI, in its mid-quarter review on December 16, had indicated that although inflation has started to ease, it is not yet in the comfort zone.

The central bank also said it needs to continue vigilance on the inflation front to prevent build up of demand side pressures, adding there was an upside risk to its projection of 5.5% inflation by March.

“We expect the RBI to hike policy rates as inflation is proving to be sticky with commodity prices firming up,” said Puneet Pal, fund manager, UTI Mutual Fund.

Fund mangers envisage inflation to be around 7-8% next year.
India’s primary articles inflation in the week ended December 11 jumped to 15.35% from 13.25% a week ago, with the index rising 1.8% on week to 187.9.

“The RBI may not raise rates in January, but a rate hike is likely between Jan-Mar,” said Lakshmi Iyer, head-fixed income and products, Kotak Mahindra Mutual Fund.

A few fund managers expect the RBI to cut cash reserve (CRR) ratio, while a few were of the view that doing so may go against the RBI’s anti-inflationary stance.

“CRR cut is the easiest, but it will have implication for inflation,” said R Sivakumar, head-fixed income and products, Axis Mutual Fund. “There is panic about liquidity, so the RBI will think about some other means to ease liquidity crunch,” he added.

In 2010, the RBI hiked repo rate 150 bps to 6.25%, reverse repo rate 200 bps to 5.25%, and CRR 100 bps to 6%. The SLR was briefly hiked to 25% and again cut to 24%.

UTI Mutual Fund’s Pal expects liquid schemes to post 7.80-8.10% returns in Jan-Mar and short-term income funds to deliver 9.0-9.5% returns in the first half of the year. Long duration funds may post annualised returns of 8-8.5%, he added.

The mutual fund industry, with assets worth Rs6.652 lakh crore under management, has witnessed huge inflows in liquid and ultra short-term schemes, and the trend is likely to continue in 2011.

Assets of income funds, comprising ultra short-term plans, in November stood at Rs3.31 lakh crore, while that of liquid funds was Rs99,190 crore.

Over a one-year period, liquid schemes have delivered average 5.09% returns, while short-term debt funds registered 4.93% annual average returns. Long-term funds delivered annualised average returns of 4.43%.

Fund managers anticipate returns on gilt schemes to be hit on rising rates and a likely huge borrowing in 2011.

“Gilt funds may face some challenges, the budget for the supply (of gilts) will decide about gilts,” said Suyash Choudhary, head-fixed income, IDFC Mutual Fund. In a rising rate scenario, schemes that invest in long-term securities are more susceptible to post a decline in net asset values than their short-term counterparts.

Fund managers expect the 10-year gilt yield to be in the band of 8-8.5%.

“We expect the 10-year yield on the sovereign benchmark to hover between 8.10-8.50% next year though the inflation trajectory and fiscal deficit numbers will be the key variables to watch out for,” said Pal of UTI Mutal Fund.

“There is no scope for a gilt rally, so the budget will decide whether gilts can do well, if there is a positive supply calendar,” said Sivakumar. “Volatility (in the bond market) is likely to continue into 2011 on the RBI’s fight against inflation,” said Shriram Ramanathan, fund manager, Fidelity Mutual Fund.

NewsWire18