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Debt funds turn attractive

Aabhas Pandya

After lying low for over a year amidst the euphoria for equity funds, debt funds are making a strong comeback despite the increased burden of dividend tax from 11 per cent to 22 per cent. With the sharp fall in net asset values (NAVs) of equity funds in the last couple of months, investors are beginning to find merit in debt funds as safety takes precedence over returns. Mutual fund officials say besides making fresh investments, investors are opting for a lateral shift from equity to debt funds.

Investors poured millions of rupees into equity funds and IPOs in the last year on the back of a booming equity market and tax breaks for equity funds. With astronomical returns the norm, rather than the exception, investors threw caution to the wind and rushed for equities. No wonder, investors have burned their fingers in the recent meltdown.

"Corporates, with surplus cash, were investing in equity earlier, but have quickly shifted to debt funds. Individual investors who had purchased technology funds at the peak have also moved out with a loss and are nursing their wounds in debt and balanced funds," says Ashutosh Bishnoi, president and CEO, JM Asset Management. "Yes. Debt flows have increased compared to the past when the equity markets were booming," points out Vineet Udeshie, vice president, Alliance Capital.

While numbers are not yet available, market intermediaries also confirm the trend. They say with a sharp drop in badla rates, lenders in the badla market have also shifted to debt funds. "We have been getting bulk investments from badla financiers in debt funds and monthly income plans as returns are much better," says one intermediary. "All such players who were lending in the badla market have shifted en masse to bond funds, government securities funds and high-liquidity debt/cash funds," adds Bishnoi. For the week ended May 12, the badla rates on the Bombay Stock Exchange were around 6 per cent per annum.

However, mutual funds see the current inflows into debt funds as a temporary investment avenue as investors wait for the equity markets to firm up again. Although debt funds have given a one-year average return of 13.70 per cent for the year ended April 28, these returns are unlikely to be repeated this year. The impressive returns were largely on the back of a fall in interest rates but this trend seems to have been arrested now.

"People have shifted to debt funds from equity funds due to a sharp fall in NAV. This may be a short-term aberration as an investor will not be happy with 9-10 per cent returns compared to an inflation of 6 per cent based on Wholesale Price Index and 8-9 per cent based on Consumer Price Index," says Nilesh Shah, chief investment officer, Templeton India. Adds Bishnoi, "Most exposures are committed for a three to six month period. If the market shows strength, at least part of the money will flow back in hope of recovering the losses."

However, those investors, who recently shed inhibitions for equities and ended up losing in the current fall, are now expected to stay with debt funds for a longer duration. Clearly, it's a case of once bitten, twice shy.

Source: Value Research

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