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Income funds light up way to wealth

Peaking interest rates on deposits and high returns on debt funds have made debt instruments attractive — you can get fair to high returns along with safety of capital, a rarity in these days of market correction, reports Sandeep Singh.

india Updated: Dec 30, 2008 20:50 IST
Sandeep Singh

Peaking interest rates on deposits and high returns on debt funds have made debt instruments attractive — you can get fair to high returns along with safety of capital, a rarity in these days of market correction.

“Given the drop in headline inflation and ongoing focus on boosting economic growth, we could witness further rate cuts,” said Santosh Kamath, chief investment officer (fixed income), Franklin Templeton Investments. “In such a scenario, long bond funds and gilt funds could provide capital appreciation.”

Experts say that income funds —mutual funds that invest primarily in corporate bonds — are best placed for investment in the current market scenario. This is because the spread between government securities and corporate bonds is around 3-4 per cent.

A fall in interest rates increases the price of the bond paying higher interest rate (reducing the yield) and the holders of those high-interest paying bonds can trade them at higher rates, generating higher returns. This is how the income and gilt funds have generated returns in excess of 20 per cent over the last one year.

As debt looks attractive it is important that investors pick the right product from a mix of instruments available — employees’ provident fund, bank deposits, post office deposits, gilt funds, income funds, and fixed maturity plans.

For the salaried, while provident fund is a given, investment in fixed deposits of banks look tempting. The pre-tax returns from bank deposits hover around 10 per cent — Punjab National bank offers 10.5 per cent per annum for deposit between one and two years, while State Bank of India offers 10 per cent per annum for a 1,000-day deposit.

When it comes to mutual funds, gilt funds — mutual funds that invest in government securities — emerge at the top in terms of safety (if held to maturity) and returns. The average return generated by gilt funds over the last one year stands at 22.6 per cent.

The yield on government securities has come down from around 9 per cent to 5.5 per cent in the last six months and experts believe that it is expected to go down further.

But since the downside is low, they make a good case for investment only for the shorter term, said Surya Bhatia, a Delhi based financial planner. “Income funds look best for investment in these times with a one year investment horizon,” he said.

Income funds have generated high returns but are susceptible to default risk — companies that the fund invests in not paying the interest or principal back. The average one-year return of income funds stands at 12.5 per cent.

“With expected fall in rates, the spread between g-secs and corporate bonds is likely to compress going forward and that makes them attractive for investors in the current environment,” said Nilesh Shah, deputy-managing director, ICICI Prudential AMC.