With equity markets and equity mutual fund (MF) schemes taking a breather from the global turmoil that impacted India in the past month, the action is slowly turning to the debt market. Long-term bond funds are gearing up for falling interest rates in India. Debt funds do well when interest rates fall as there is an inverse relationship between the two.
Long-term bond funds have increased their duration and their average maturity or the number of years left for your debt fund's existing scrips to mature. Already, fund houses are offering potentially attractive fixed maturity plans (FMPs), while six-month short-term bond fund returns have shot up to about 7-8% per annum during the past six months.
Falling interest rates
To combat rising inflation, the Reserve Bank of India (RBI) has increased the key interest rate 10 times since April 2010.
But that is largely expected to change. "Crude oil prices globally are expected to correct, especially since the crisis in Libya is expected to be resolved soon," said Sandip Sabharwal, head, portfolio management services, Prabhudas Lilladher.
A slowing growth can also be another reason why interest rates could soon start falling. The growth in credit offtake of firms have been moving down over the past one year. On the contrary, deposits have grown by 17.3% as on July 29 against 16.5% at the turn of the year.
Apart from inflation that may take its time to come down, fund managers are watching the fiscal deficit situation. "Since the government incurs a bill in food and fertiliser subsidies, we need to watch how much it spends and earns this year," said Alok Singh, head, fixed income, BNP Paribas Asset Management (India) Ltd.
However, there is no one answer on how soon inflation will drop.
Why long-term bond funds?
Although it is anybody's guess when interest rates will actually begin to fall, it makes sense to take a partial exposure to long-term bond funds now. Debt funds managers have started advising investors to put money in them already.
Long-term bond funds have started taking exposure to debt scrips with longer tenors. Besides, dynamic debt schemes that have the flexibility to invest in scrips across maturity periods have also increased their average maturity periods.
So, if you wish to take a bit of risk for the chance of getting higher returns, go for long-term bond funds.