Personal Finance: Surviving The Storm

PERSONAL FINANCE: INCOME FUNDS
Surviving The Storm

Portfolios comprising low-maturity bonds are a solution for bond-fund insecurities. But investing in new income funds is the best option.

By Roshni Jayakar

For bond fund fetishists, July was a cruel month. Ever since July 21, when a worried Reserve Bank of India (RBI) raised the banking system's cash reserve ratio (CRR) by 50 basis points to 8.50 per cent and hiked the bank rate to 8 per cent, bond (or income) fund lovers have been down in the dumps. They've been seeing the net asset values (NAVs) of fixed return income funds plummet. The reason: most income funds park large chunks of their investible corpus in government securities. And, when CRR is raised, banks mop up liquidity from the system so interest rates go up. When interest rates go up, the prices of government securities fall as the yield curve moves up.

As it happened, following the RBI directive the prices of government securities dropped between 45 paise and Rs 3.10 depending on their maturities. The net result: bond fund NAVs moved southwards. Between July 20 and 24, the NAVs of open-ended income schemes fell by an average of 1.6 per cent, while the liquid schemes fell by 0.07 per cent. In a 15-day period (July 14 to August 1), the decline in values (See Southward-Bound Syndrome) varied from 0.12 per cent (JM Liquid Income Fund) to 1.44 per cent (Jardine Fleming India Bond Fund).

In such a market, what does an inveterate income fund investor do? Of course, some rear-guard action is often taken by the fund managers, who tend to reduce the maturity of the securities in their portfolios. That way it is easy for investors to cash in on new opportunities. Says Milind Nandurkar, 32, Fund Manager (Fixed Income), Sun F&C Asset Management: ''By adopting a defensive strategy in the last four months, we have suceeded in reducing the weighted average maturity of our portfolio to one year from 2.5 to three years.'' And, Templeton India Income Fund, has reduced the average maturity of its portfolio from seven years plus in April to 2.5 years at present. Adds Sanjay Chaudhary, 30, Head of Research, Credence: ''In the uncertain bond market, it's much better to be liquid.''

A portfolio of shorter average maturity allows for greater ease in switching to new investment opportunities. But, if a fund manager continues to have a portfolio with securities of longer term maturities, when interest rates rise the returns could be negative. And, a fund with a smaller portfolio is easier to churn. But a small fund has its downsides. Argues Nilesh Shah, 33, Fund Manager (Fixed Income), Templeton India Income Fund: ''An oil tanker is always slower than a speed boat while taking a U-turn, but in a storm the speed boat may go down, but an oil tanker will survive the storm.''

Taming the times

Yet, given the present circumstances, it's better to ride a speed boat. If you had invested in an income fund in April, 2000, with a six-month time horizon, with the drop in the NAV, your returns would be negative. What can you do? You could shift your investment to the money market or liquid funds. That way you could earn a return on your investment and yet not face the risk of losing your capital. But, if you have invested in an income fund with a three to four-year time horizon, just hang in there because the interest rate cycle will turn. Suggests an analyst with HDFC Bank's mutual fund advisory: ''Take advantage of the drop in the NAV to buy more units of the income fund.'' Of course, if you have a time horizon that is less than three years but longer than six months, you could be better off to shift to funds with relatively smaller corpus.

And don't worry about the entry and exit loads that funds charge. The exit load varies from 0.25 per cent to 0.50 per cent of the NAV. And, if you have been an investor for more than six months, you can exit it without a load. As for entry loads, most small corpus funds don't charge a fee. But one exception is the Zurich India High Interest Fund, which levies a load of 1.75 per cent.

But remember, when you're switching from one fund to another, you may have to pay capital gains tax. Profits from income schemes (if the units are held for more than 12 months) are treated as long-term capital gains and taxed at 10 per cent (after discounting for the rate of inflation. If, however, the holding period is less than 12 months, then the capital gain tax is levied at 20 per cent. Of course, individuals are also be eligible for benefits under section 54ea (if the entire sale proceeds are invested in mutual funds units and are locked in for a three-year period) or 54eb (if the capital gain portion of sale proceeds is invested in mutual funds and locked-in for seven years).

But rather than switching from large corpus funds to small ones, the best option is to find an income fund IPO. As the fund manager of a new fund would be investing in the current market (and, therefore, factoring in interest rates and the yield curve for securities), he wouldn't have to carry the baggage of long-term securities. Neither would you.

Issue Contents Write to us Subscriptions Syndication