Income fund slump: This too shall pass - Views on News from Equitymaster

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Income fund slump: This too shall pass

Sep 17, 2001

In the aftermath of the terrorist attacks in the US, domestic bond prices have slumped a little too dramatically for investor comfort. Income fund investors are now asking questions like Ė how can income fund net asset values (NAVs) fall? Arenít income funds meant to be a safe investment proposition? To be sure, income funds are safe. This safety stems from the creditworthiness of its investments (AAA/P1+, sovereign-rated gilts). However income funds are secure from credit risk but they continue to be subject to interest rate risk from economic factors like oil prices, forex position, inflation.

Income funds arenít volatile, or to put it more accurately they arenít as volatile as their equity counterparts. However, in the aftermath of the US attacks, equity and fixed income markets alike, have been affected. This in turn has taken a toll on mutual funds that invest in these instruments.

Over the past couple of days, we have had nervous income fund investors asking us if they should exit and switch to liquid funds. The answer to that question depends on the investment horizon of the investor. Frankly when you invest in an income fund, you implicitly acknowledge two facts, often without realising it. Fact one Ė you have reposed faith in a fund managerís capabilities to steer through the choppy moods of the fixed income markets. Fact two - you want to remain invested at least for 9-12 months as the exit load would make it unattractive to exit before then and because you find a dearth of liquid and tax efficient instruments in the market comparable to an income fund.

Standard Chartered Mutual Fund, a leading debt fund house, had this to say to investors: Long term investors should use this correction to invest in debt funds as we believe that our bond markets will remain strong on the underlying liquidity in the local market as well the likelihood of further interest rate cuts across the globe.

We do not foresee any sharp fall in prices in the near term and any attempt to "time" the market is not advised. Hence we also do not advise existing investors in income funds to switch to liquid funds.

It would be very impulsive to exit every time there is a crisis in the capital markets. Fund managers are hired just for that. Intelligent investors can actually use this slump to their benefit by entering an income fund at this point in time when net asset values (NAVs) have dipped. Existing investors must understand that everything cannot be hunky-dory all the time and the bull-run in bond prices had to come an end at some time. They must also understand capital markets will always witness some tumult, but like all other crises, this too shall pass.

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