There is some good news for investors who feel they missed the rally in debt mutual funds. Rahul Goswami, chief investment officer of fixed income at ICICI Prudential AMC, says that there is still time for investors to make money.
"There is reasonable opportunity to make money in high duration and medium duration income and debt funds," he says. (Watch Video)
Debt funds invest in short and long-term debt securities of the government and the corporate sector, with an objective to earn returns in the form of interest income and capital gains. It is meant for investors who want to optimize current income by assuming low to moderate levels of risk. When interest rates go down, price of debt securities that were issued earlier goes up as they carry a higher rate. This helps debt funds to post capital gains. Debt funds also earn interest income from the debt securities they hold.
Over the past one year, the average return from debt funds that invest in medium and long-term gilts (government bonds) ranged nearly 18 per cent on expectations of interest rate cuts from the Reserve Bank of India, in the wake of easing inflation. Top funds gave returns in excess of 20 per cent. On the other hand many banks have been cutting their fixed deposit rates in anticipation of lower lending rates in the future.
The RBI has in fact cut rates in twice this year, citing declining inflation. Mr Goswami says there is a strong foundation for RBI rates to go even lower, with improvement in India's current account deficit and soft commodity prices. He expects the central bank to lower rates by up to 50 bps for the rest of of this year and the next rate cut could come either in April or June.
Mr Goswami said that debt funds that invest in five-to-seven-year instruments are "sweetly" placed to gain from the easing interest cycle. The government and the RBI have agreed to set a consumer inflation target of 4 per cent, with a band of plus or minus 2 percentage points, from the financial year ending in March 2017. If inflation falls to 4 per cent, there is scope for interest rates coming down by 150-175 bps in the next two to three years, he added.
India's current account deficit narrowed in October-December from the previous quarter on the back of slumping oil price and analysts said it should move into surplus in the March quarter for the first time in eight years. A lower current account deficit eases the pressure on RBI to keep rates high.
However, Mr Goswami says there could be some short-term volatility for Indian bond prices if the US Federal Reserve hikes rates this year. Analysts are expecting that the US Fed could prepone rate hike to June of this year in the wake of steadily improving jobs data. A hike in US rates could make assets in that country attractive for investors who have poured big money into Indian debt and equities.
Mr Goswami says the US hikes rates have mostly been factored into in Indian bond prices.
For him, the key thing to watch is the global oil prices, which he says is critical for India's inflation scenario. "In bigger scheme of things, if oil prices remain subdued at $50-60 a barrel that will have a much favouarable impact rather than US yields going up by 25 bps," says Mr Goswami.
He expects that global commodity prices are likely to remain soft in the next two to four quarters, helping keep inflation in a comfortable zone.
Debt mutual funds score over fixed deposits in terms of their taxation. Investors can claim indexation benefit on debt mutual fund schemes after three years, significantly lowering their tax outgo on the gains. On the other hand, the interest on fixed deposits is fully taxable. It is added to the income of the investor and taxed as normal income.
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