Income funds: Caught napping

S. Vaidya Nathan

ONE category of funds that was rudely shaken up was income funds.

And much of it had to do with the firefighting measures resorted to by the RBI to stabilise the rupee. Central to this strategy was the move to raise the cash reserve ratio and the bank rate, and force corporates to repatriate funds lying abroad. These moves led to an uptrend in interest rates and a steepening of the yield curve.

This led to a fall in the prices of bonds, and virtually all the funds had a rather poor quarter. The sharp drop in NAVs was more pronounced for funds with exposures to the long-term end of the market. Interestingly, within the ranks of income funds, the liquid funds or treasury management products performed better.

These funds are mainly targeted at the corporate sector and other institutional investors requiring short-term liquidity. The investments are also in short-term instruments. Since these appear to have weathered the storm better than long-end papers, almost all the products on offer generated returns of 2 per cent or slightly more for the quarter.

Among other types of income funds, this level of return was achieved only by the gilt funds of Zurich India and Kotak Mahindra Mutual Fund. The conventional debt funds, targeted at retail investors, did not have a good quarter, as the Table shows.

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Only Escorts Income Plus and Dundee Public Sector Fund recorded fairly respectable returns, of around 1.75 percentage points. Most funds managed returns of less than 1 percentage point. Though such a trend may be an oddity, it does show that mutual funds as a whole did not make the right calls on debt market developments.

Some more insipid performances may lie ahead, till there is stability in the interest rate outlook. But most mutual funds appear to be better placed now than they were before the recent round of rupee depreciation and the RBI moves initiated in July/August 2000. The funds have reduced the portfolio maturities, pared exposures to government securities, which tend take a harder knock being relatively more liquid (paradoxical, but this does happen in India's shallow debt market), and taken to holding cash equivalents to an increasing extent.

Money market mutual funds had a good quarter, with the yields from the Kothari Pioneer Money Market Fund hovering close to 10 per cent for most of the quarter. This just confirms that for much of 2000, cash/cash equivalents could have been a better option, given the volatility.

With the prospect of an upward trend in interest rates (though the RBI would like rates to be lower to spur growth), the re-positioning of the portfolio of most income funds may help avoid the kind of shocks experienced in the last quarter.

From the point of view of investors, it may be better to avoid getting into any close-end income fund option. Even among open-end funds, it may be better to stay in cash/cash equivalents and take exposures in income funds through periodic investing rather than investing in one go now. This may be the better way till the interest rate scene stabilises, and this may take at least six months.

But rather than wait for any changes to happen, taking the systematic investment route, diversifying across debt funds, post-office schemes for long-term purposes and select fixed deposits, could ensure that investors do not attempt to time the market in a big way, and yet manage reasonable returns over a two- to three-year time-frame from their debt portfolios.