With the stock market having run up 82 per cent since March, investing in stocks over the short term is fraught with risk due to the possibility of an imminent correction. When this fact is juxtaposed with the prospects of a flattish interest rate over at least six months, a clear case builds up in favour of short-term debt funds. Here’s why: While interest rates are expected to remain volatile for sometime, fund managers believe there won’t be any significant movement in any one direction at least over the short term.This makes it safer to invest in shortterm debt instruments such as liquid plus funds, floaters and short-term debt funds, which according to fund managers are less sensitive to changes in interest rates. On the other hand, a rise in interest rates affects long-term bond funds the most.
“In future, the trajectory of yield curve will be contingent upon three key developments: government’s borrowing programme, economic recovery and the interest rate scenario. While heavy government borrowing and bumping up of inflation may have a long-term impact on the bond markets, the yields for the short-term period will continue to remain low,” says Sujoy K. Das, Head (Fixed Income), Bharti AXA Investment Managers. Lower yields on bonds translate into higher net asset values (NAV) of debt funds.
Parijat Agrawal, Head (Fixed Income), SBI Mutual Fund, too, expects interest rates to be flattish before going up again over the long run. “Rising commodity prices and higher GDP growth could harden interest rates over long term. It is certain that RBI may not reduce rates further, but a lot will depend on the Budget.”
All categories of the short-term debt mutual funds have performed well in recent past. Over the past one year, short-term funds have given an average return of around 10.72 per cent, compared with 8.20 per cent return on short-term floating rate funds, and 2.48 per cent return on balanced funds category. Typically, short-term debt funds invest in shortterm corporate debt, money market instruments and call money. Says Agrawal: “Short-term debt funds are the best bet for uncertain investors.
While liquid funds do the job of insulating the investor’s portfolio from high interest rates well enough, shortterm debt funds do it as well and can even give a slightly higher return.” Investors could also opt for floating rate funds. Floaters, which invest largely in floating rate paper, are ideal for investors with investment tenure of around 12 months. Since coupon rate is revised periodically, the amount of risk these funds carry is pretty low.