Layman's Guide To Debt Mutual Funds

<?xml version="1.0" encoding="UTF-8"?><root available-locales="en_US," default-locale="en_US"><static-content language-id="en_US"><![CDATA[<p>Killol Pandya, head of fixed income at Daiwa Asset Management and Lakshmi Iyer, Head of Product &amp; Fixed Income – Kotak Mutual Fund, talk to Businessworld's <strong>Tanushree Pillai</strong> about the nuances of debt mutual funds&nbsp; –&nbsp; where your money is invested, what kind of returns should one expect and how long should one remain invested.<br><br><strong>What are the different kinds of debt mutual funds that are available for retail investors?</strong><br><strong>Pandya:</strong> Mutual fund schemes which invest in debt instruments fulfill several investor needs. There are Liquid and ultra short term funds which are oriented at the Institutional and semi- Institutional segment and provide good returns and overnight liquidity to the investors. For investors having a slightly longer investment horizon, there are short term debt funds. For investors who have a medium to long term investment view, there are Medium term and income funds. Some investors have a pre-determined investment horizon; these investors can use the Fixed Maturity Plan (FMP) route to make meaningful investments. We also have debt oriented hybrid funds by way of MIPs etc which provide a good asset mix for investors who have a larger risk-return appetite.<br><br><strong>Iyer: </strong>The Indian mutual funds industry offers a range of investment avenues through debt funds,&nbsp; servicing a spectrum of investors; be it for investors with short-term horizon of as little as a day, or for long-term holdings.<br><br>Consequently we have liquid funds, short-term debt funds, and long-term bond/gilt funds. Over and above that, close ended debt funds (also termed as FMPs/QIPs) are also a key retail offering.<br><br>Mutual funds also offer hybrid debt funds, which are recognized as monthly income plans and balance funds. These funds primarily are mix of various asset classes which are devised to cater to specific investment needs of investors.<br><br><strong>Please elaborate each one and how different it is from the other?</strong><br><strong>Pandya: </strong>Different Mutual Fund (MF) schemes provide different risk-return profiles. They also represent a different profiles in terms of investment horizons of investors. In that sense, each of the debt MF products provide value to the investors at discrete points on the Risk-Return-Investment horizon matrix.<br><br><strong>What kind of allocation (percentage wise) should retail investors go for (keeping in mind a certain age bracket) </strong><br><strong>Pandya:&nbsp;</strong> Allocation of money in different MF products does not only depend on the age of the investor. More importantly, it is a function of where we are placed on the interest rate cycle. As things stand now, we appear to be at the end of the interest tightening cycle. We are likely to experience a period of interest rate stability before the rates begin to soften. So, we advise retail investors to stay invested in debt funds while keeping about half their money at the shorter end of the curve (liquid and ultra short term funds) and venture out towards products which are longer on the yield curve with the balance money put in a calibrated manner.<br><br><strong>Iyer: </strong>That is dependent on the investor's investment profile and objectives. It is a function of interest rate cycle. If signs of peaking are visible debt should increase towards long duration funds and vice-versa. Over and above that, the investors can also generate competitive returns by investing their excess cash balances in liquid funds.<br><br><strong>What are the benefits of debt mutual funds?</strong><br><strong>Pandya: </strong>The very nature of the underlying instruments such as money market instruments, sovereign bonds and debentures indicate a pre-determined fund flow. While debt markets are exposed to interest risks, reinvestment risks and market risks, the impact of these risks can be managed in a relatively better manner. Empirical evidence suggests that debt markets are relatively less volatile than equity or forex markets. The inherent stability, relative probability of protecting capital and making some returns thereon, is the key advantage of debt funds.<br><br><strong>Iyer: </strong>A relative regularity of return and performance vis-à-vis the other asset classes is one of the key advantages of the debt mutual funds. Other than that, the risk on capital invested is far reduced (provided the fund is invested in creditworthy instruments) vis-à-vis the other asset classes. Thus the possibility of a capital loss in fixed income investment is very low. Also, if the debt investments are timed with the peaking of the interest rate cycle, the investors have the potential to make modest capital gains. <br><br><strong>Given today's high interest rate scenario, what kind of returns are debt MFs giving?</strong><br><strong>Pandya: </strong>Currently, debt funds are giving one month returns ranging from 8 per cent to 20 per cent, depending on the underlying asset class and the investment period involved. These returns may be a product of investments at high yields as well as profits booked on account of the significant softening seen in Gilt market yields.<br>&nbsp;<br><strong>When should a retail investor think of investing in debt MFs?</strong><br><strong>Pandya: </strong>I do not subscribe to the policy of trying to 'time' the debt markets. I hold that debt fund investments ought to be a perennial feature of every retail portfolio. As I have already shared with you, debt funds provide a range of investment solutions and retail investors may find value in a combination of the offerings at all points in time.<br><br><strong>Iyer: </strong>An investor can invest into the debt funds in almost any kind of market or circumstance. However, the investor is advised to calibrate across the short and the long duration funds according to the interest rate environment prevalent. <br><br>When the interest rates have peaked, the long duration funds, in a 1-year timeframe, tend to be relatively better performers. On the other hand, in a rising interest rate environment, money market funds are more advisable. Whereas, in a range bound market, short duration debt funds find more traction. The unique thing about debt funds is that there are products available for every business and interest rate cycle. <br><br><strong>In the past year, how have the returns of debt MFs varied and why?</strong><br><strong>Pandya: </strong>Debt MF returns are always subject to market risks and more importantly to interest rate risks. As a rule of thumb, interest rates hardening leads to a drop in debt MF returns. In the past 6 to 8 quarters, we have seen about 13 hikes from the Reserve Bank of India (RBI) amounting to a total of about 375 bps. This was a natural fallout of the interest tightening regime seen by our economy during the period. In such a scenario, it is difficult for debt funds to outperform. However, funds which were oriented at the shortest end of the curve (viz. Liquid and ultra short term funds) have managed to give relatively better returns throughout the period.<br><br><strong>What type of debt instruments do debt MFs invest in?</strong><br><strong>Pandya: </strong>Debt funds may invest in near cash assets such as CBLO &amp; reverse repo, Money Market instruments such as Treasury Bills, Commercial Papers and Certificates of Deposits as well as instruments such as sovereign bonds, Debentures, Pass through certificates, Fixed Deposits and other allied structured debt obligations. In addition, debt funds may use debt derivatives such as Overnight Index Swap (OIS) to hedge their portfolios subject to SEBI guidelines. Debt oriented hybrid funds may also invest in additional asset classes such as Equities and gold subject to the profile of the offering.<br><br><strong>As a percentage of the total MF pie, how much are debt MFs?</strong><br><strong>Pandya: </strong>As per the AMFI's monthly data of category-wise assets under management as on December 31, 2011, debt mutual funds which include Liquid/Money Market Funds, Income and Gilt Funds form approximate 70% the total industry AUM. <br><br><strong>What kind of returns is expected from debt MFs in the next six months?</strong><br>Returns given by Mutual Funds are always subject to market risks and dependent on a number of factors. The returns given by debt MFs in the coming months shall primarily depend on the interest cycle. The speed and strength of movement by the RBI in terms of reference rates shall be the primary driver behind debt fund returns. In addition, WPI inflation, rupee movements and the upcoming budget shall be watched in order to determine the expected returns. Nonetheless, it may be fair to state that 2012 (calendar) may be better for debt funds than 2011 was and debt MF returns may approach double digit returns in the current calendar.<br><br><strong>Where would you invest your money in, given the current scenario?</strong><br><strong>Pandya: </strong>As I have stated earlier, we appear to be at the end of the interest tightening cycle. We are likely to experience a period of interest rate stability before the rates begin to soften. As a function of this, we advise retail investors to stay invested in debt funds while keeping about half of their monies at the shorter end of the curve (Liquid and ultra short term funds) and venture out towards products which are longer on the yield curve with the balance monies albeit in a calibrated manner. However, I hold that it may not be possible for the retail investor to keep track of the markets on his own. In such cases, I would recommend a dynamic fund. Such funds permit the Fund Manager to seamlessly move across the yield curve and alter the portfolio's duration in order to optimise returns for the investor while also keeping a check on the risks involved.<br><br><strong>Iyer: </strong>The nature and scale of investment must almost always be a function of individual's investment objective and risk-return profile. Having said that, in the current economic environment, the steep slack in the gdp growth and a rapidly declining inflation; presents the possibility of a gradual downward rate-revision over the course of next 12 months.&nbsp; Moreover, the renewed FII interest in India, as demonstrated by the approximstely $5 billion net inflow into the domestic capital markets, also indicates of a possible change in the equity market circumstance in the year ahead. Consequently, we would prefer the equity allocations to be in the 20-35 per cent range, with predominant allocation for large-cap funds. <br><br>The allotment of these investments through the means of SIP may prove to be an additional risk mitigating factor. Moreover, the investor can look to have a skew towards short term funds &amp; FMPs on the debt portion with some position in the long duration space, so as to position oneself for possible capital gain opportunities in the year ahead. The investor can also look to obtain around 5-15% exposure in safe-haven (traditionally) asset like gold by means of Gold ETF and/or Gold Fund of Funds.</p>