Inflation-beating debt funds come to investors rescue

IDFC Premier Equity, an equity fund, which boasts of a sound long-term record, declined 15 per cent in 2011 even as a debt fund from the same stable, IDFC Dynamic Bond, delivered over 11 per cent. That was the kind of divergence in performance seen between the equity- and debt-fund universes this year.

After 2008, debt funds have once again come to the rescue of investors struggling to get positive returns from their mutual fund portfolio.

With an average returns of 8.2 per cent in 2011 (returns up to December 24), the 350-odd debt funds, excluding fixed maturity plans, convincingly beat the average minus 22 per cent delivered by diversified equity funds. The Sensex fell 23 per cent in this period.

But did the debt category beat inflation? They did, if you consider the Wholesale Price Index reading in 2011. The WPI expanded by 7.9 per cent up to November. At least two-thirds of the debt funds beat this price rise.

The long and short of it

Some of the top debt-fund performers this year managed gains of 13-14 per cent. But then, only investors who chose the right category of funds within the debt universe would have managed such high returns.

For instance, schemes that invest in instruments with short-term maturities – also called short-term funds – outperformed those that invest in long-term bonds and gilts. The former returned an average 8.8 per cent against a 6.3 per cent average gain managed by gilt funds.

Some of the winners in the short-term category include Sahara Short Term Bond, Peerless Short Term and Sundaram Select Debt Short Term. These funds mostly took focussed exposure to certificate of deposits from banks, commercial papers from even mid-sized companies and other money market instruments, all with short-term maturity of 1-4 months. With interest rates in 2011 trending upwards, these funds benefited from the high yields in short-term instruments.

Yet another category, called income funds, also produced some chart toppers. Funds such as Escorts Income Plan, SBI Dynamic Bond and IDFC Dynamic Bond for instance, managed returns of 11-12 per cent.

These funds had a mix of short and long-term instruments and dynamically switched between the two.

According to their latest available portfolio, they had invested in bonds of NBFCs and companies that have a maturity of anywhere between 1-6 years.

This said, long-term funds have seen a recent pick up in performance. Declining yield in long-term government securities in the last two months, prompted a rally in their prices. 10-year government security yields for instance, declined from 8.9 per cent beginning November to 8.4 per cent now.

This resulted in the prices of these instruments going up, providing opportunity for capital gains to debt funds that held them.

Buttressed by this sharp rally, gilt funds such as Baroda Pioneer Gilt, Birla Sun Life Gilt Plus and IDFC Government Securities caught up towards the fag end of the year, delivering 10-12 per cent in 2011.

More rally?

What should be an investor's strategy towards debt in 2012? According to Mr Dhruva Raj Chatterji, Senior Research Analyst with Morningstar India Research, investors who can take volatility may consider exposure to long-term funds. Any spurt in inflation can cause volatility in these funds. The rest, he says, will be better off with dynamic bond funds, where investors need not take the call on interest rates.

Mr Arvind Chari, Debt Fund Manager at Quantum Mutual also shares a similar view in his 2012 outlook note. He recommends a shift from the relatively passive fixed maturity plans to more actively managed debt funds that will see capital gains, if interest rates fall further. For those who do not take the mutual fund route, he advocates locking in to longer maturity fixed deposit rates.

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