Why Income Funds are witnessing rise in AUM? - Outside View by PersonalFN

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Why Income Funds are witnessing rise in AUM?
May 24, 2013

In the last fiscal year amid a slowdown in economic growth rate, the Reserve Bank of India (RBI) as many of you may have observed has taken a rather calibrated stance on reducing policy rates. This is because while handling the growth-inflation dynamic in the monetary policy, Wholesale Price Index (WPI) inflation was plateauing above the 7.0% plus mark for quite some time causing discomfort to the central bank. But now that WPI inflation has mellowed down and moderation seen, it has brought in some sigh of relief which has induced central bank to address to growth risks, although again in a very gradual manner.

AUM of income funds on a rise
Data as on April 30, 2013
(Source: AMFI, PersonalFN Research)

The Indian debt markets too amid this scenario have kept rational expectations and with gradual steps taken by RBI to reduce policy rates along with liquidity situation being addressed to (via cut in Cash Reserve Ratio (CRR) and / or Open Market Operations) at appropriate point in times; "income funds" have attracted debt mutual fund investors. As on April 30, 2013 the Assets Under Management (AUM) of income funds is at Rs 4,22,300 crore - it being a three-year high; and from last April too there's been an increase of 36%.

Tight liquidity situation at present along with expectation of further easing in monetary policy aided by further drop in WPI inflation for April 2013 to 4.89% - a 41-month low, has induced many to look at income funds. But it is noteworthy that most of the inflows has come in the ultra-short-term and short-term income fund category as fund managers expect the yields of shorter tenure bonds to firm up in the near future due to tight liquidity conditions and investors too are allocating their hard earned money to shorter maturity debt papers. Long-term income funds have also seen increase in inflows exuded by expectations of further rate cut from the RBI now that WPI inflation is placed below the comfort level of RBI.

At present yields of shorter maturity papers are hovering around 8.50% (upto 1 year maturity), while those of longer maturity papers near 7.50%. Fund managers are expecting the coupon rates of longer duration debt papers to remain low, as interest rates are expected to fall over the next one year if WPI inflation continues to remain below RBI's comfort level.

A strategy should debt investors...

At present while taking exposure to debt mutual fund schemes and fixed income instruments, it would not be very prudent to take exposure to longer duration instruments as most of the rally has already occurred ahead of expectation of a 25 basis points (bps) policy rate cut from RBI in the annual monetary policy 2013-14. With drop in WPI inflation for April 2013 while expectations of a 25 bps rate cut have been built yet again, PersonalFN is of the view that the central bank would also keep a watch on May 2013 WPI inflation data. Likewise, they would take into account the trade deficit and Current Account Deficit (CAD) too which is depicting a worrisome picture. At present, as many of you may be aware, India's trade deficit for April 2013 has widened upto U.S. $ 17.8 billion led by high gold imports. The Current Account Deficit (CAD) data too is expected to touch a record high of 5.0% of GDP in 2012-13 (as measures to curb gold imports have only had a marginal effect thus far); so all these facets would be evaluated carefully and then the central bank would take stance whether to cut rates in its 1st mid-quarter review of monetary policy 2013-14 (scheduled on June 17, 2013).

However if one wishes to take exposure to longer duration instruments or debt mutual fund schemes holding longer maturity papers (as permitted by their high risk appetite), PersonalFN recommends that you do so by investing in dynamic bond funds, since there would always be intermediate interest rate risk involved.

In the current scenario while investing in debt instrument, it would be ideal to invest in shorter duration instruments vide debt mutual fund schemes having shorter maturity profile. Investors with an extreme short-term time horizon (of less than 3 months) would be better-off investing in liquid funds for the next 1 month, or liquid plus funds for next 3 to 6 months horizon. If you as an investor have a short to medium term investment horizon (of 1 to 2 years), you may allocate a part of your investment to short-term income funds, provided that you are willing to take some interest rate risk. Avoid investing in G-sec funds, as they may see high volatility and may not be an ideal instrument to yield fruitful returns. Fixed Maturity Plans (FMPs) of 3 months to 1 year period can also be considered as an option to bank FDs only if you are willing to hold it till maturity. Alternatively you can also invest in 1 year Fixed Deposits (FDs), as banks are offering interest on 1 year FDs in the range of 7.50% - 9.00% p.a.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


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