The Hindu Business Line : Returns on equity funds lag debt options in 2006-07

Equity funds delivered only single-digit return in 2006-07, lagging the performance of debt options for the first time in four years. Returns from diversified equity funds averaged 4.7 per cent in the financial year ended March, compared to the 6.8 per cent earned by investors in liquid funds.

Six of 10 equity funds delivered less than a 7 per cent return (liquid fund returns) and one in five ended the year in red. This unimpressive show, explained mainly by the sizeable allocation to mid-cap stocks in fund portfolios, follows three consecutive years of stellar returns in which equity funds comfortably outpaced debt options.

While equity funds have been pummelled by a yo-yoing stock market, the returns offered by debt options have climbed sharply, thanks to the year-end cash crunch and the series of RBI rate hikes.

Flagging performance

In recent months, banks have pegged up interest rates on their special deposit schemes and fund houses have been offering a 10-11 per cent return on closed end debt products (fixed maturity plans or FMPs) with 3-13 month tenures. Returns on liquid funds too, have climbed to the 8 per cent-mark in recent months.

Given the flagging performance of equity funds, should investors now switch to debt options? Fund managers feel that this decision would depend on the investor's horizon, as equities remain the best bet for those with a long-term view.

OptiMix, an investment house which tracks mutual funds, says it has "underweight" positions on equity funds right now, but cautions that locking into closed-end debt products could backfire. Explains Mr Mugunthan Siva, CIO of the fund. "Returns on FMPs are attractive. But if investors have a long-term view, a switch into FMPs makes less sense now with equities trading 12 per cent below their peak.

Different options

"While markets will remain volatile and bearish over the next three months, there will be opportunities between now and July, which will offer good entry points to long-term investors. By investing in FMPs of over three months, an investor may risk locking his money away when an opportune time to enter equities presents itself."

OptiMix has a negative view on equities in the near term because of factors such as a possible slowdown in GDP and earnings growth over the next two quarters, high inflation and the appreciating rupee, which could blunt competitiveness.

Mr Sandip Sabharwal, CIO of JM Mutual Fund, suggests that an investor has to clearly differentiate the portion of the portfolio to be set aside for equity and debt investments, and stick to this allocation, irrespective of how markets move. He asserts, "There is no way debt, as an asset class, can outperform equities over the long term. Look at rolling five-year and ten-year returns for equity funds — they have comfortably beaten debt options."

Mr Sabharwal also points out that you would be taking a "re-deployment risk", when you lock into FMPs or bank deposits.

"A year from now, you don't know what the interest rate scenario will be. Nor do you know where the stock markets will be. If stocks are 30 per cent higher than present levels, you may not like to deploy your money then."

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