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Friday, June 22, 2012

Bond Mutual Funds best for Short term

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Bond Mutual Funds best for Short term

THE Reserve Bank of India (RBI) by keeping the repo rate unchanged and not reducing CRR is indicating its willingness to sacrifice some growth to fight inflationary pressure. The RBI governor has stated explicitly that reduction of repo rate at this point of time will led to higher inflation. This has clearly disappointed the markets that had factored in a repo rate cut of 25 basis points and a CRR cut of 50 basis points.

Due to adverse macro economic development in the domestic and global contexts, the demand for credit has come down. Core inflation is expected to moderate to 3 per cent to 4 per cent levels over the coming quarters, even though food inflation is expected to remain high due to structural factors. This will give RBI elbow room to cut policy rates by 50 basis points in the coming quarters.

For individual investors, on a risk-return paradigm, debt as an asset class could continue to give relatively high accrual income in this financial year.

Investors can choose the debt category to invest, based on the time horizon of their investment. Investors, who have one to three-months horizon, can look to invest in liquid-plus funds to get high accrual income. The yield curve is inverted due to tight liquidity prevailing in the markets.

Due to this reason, higher accruals are available in the short to medium end of the yield curve. Investors can capture higher accruals by investing in short-term bond funds that invest in the short to medium end of the yield curve.

There is also some scope for capital appreciation, if RBI cut rates or liquidity improves over the coming quarters and the yield curve corrects. Investors, who have an investment horizon of six months to one year, should enter short term bond funds.

Investors, who want to ride the interest rate cycle, can invest in income funds and gilt funds because interest rates are expected to come down over the next two years as lower GDP growth will translate into lower inflation numbers in the months ahead.

Investors should have an investment horizon of one to two years when they are investing in income and gilt funds. However, on a risk-return prespective, short-term bond funds seem to be the ideal choice for the prudent investors.

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