Cash funds beat long-term debt funds

Aabhas Pandya

It's all happening in the topsy-turvy debt market with cash funds comprehensively beating their long-term counterparts in the last six months. For the six months ended August 31, 2000, cash funds have posted a return of 3.62 per cent while medium-term debt funds are a poor second with an average gain of 2.82 per cent - a yawning gap of 80 basis points. Clearly, in times of uncertainty, your cash is the uncrowned monarch! The difference in returns widens over the three-month period with medium-term debt funds tottering at 0.44 per cent with cash funds generating a stupendous return of 2.22 per cent. On an annualised basis, this translates into a whopping gap of 7.12 per cent!

With cash funds largely deployed in call money and very short-term securities, they have not only escaped unscathed from the bear grip in debt markets but have also added to their returns by lending at high call and repo rates. For instance, in August, call and repo rates have largely remained above 13 per cent. On the other hand, with their exposure to medium-term securities, debt funds have faced the fury of the tightening of interest rates and have suffered losses on their investments. In fact, the hardening of interest rates has also forced most debt funds to keep a higher portion in cash.

"With debt markets coming under the bear grip and a sharp fall in prices of bonds and government securities in the medium to long end of the market, debt and gilt funds have bore the brunt. While August has been relatively better after three months of continuous drop in i-BEX, there is still lot of uncertainty in the markets," says Nilesh Shah, chief investment officer, Templeton India AMC.

The debt market indices depict the same story. In the last three months, the i-BEX total return index has lost 0.13 per cent while the JP Morgan T-bill index has gained 1.46 per cent. The i-BEX total return index is a measure of the performance of medium-to-long dated government securities while the JP Morgan T-bill index is the benchmark for gilts with up to one-year maturity.

The current year started off on a bullish note for debt funds with a one per cent cut in PPF rate in January, followed by cash reserve ratio and bank rate cuts in April. However, the bullish fervour began to fizzle out in late April as the government's huge borrowing programme of Rs 117,000 billion coupled with rising global interest rates nudged up interest rates. "We had started to shift our portfolio to short-end of the market to cut losses when the volatility in the rupee added the proverbial fuel to fire," says a debt market analyst at a mutual fund.

The July 21 hike in interest rates, which was brought in to defend the rupee caught medium-term debt funds off guard with a sharp fall in prices of debt instruments. In fact, a number of debt funds with a sizeable exposure to government securities were the worst hit, since being most liquid, gilts lose the most when interest rates go up. "With a gradual inching up of interest rates, we had shifted to short-term securities to cut losses. However, the sudden tightness in the market has led to a sharp fall in the short-end of the markets as well, forcing us to hold a part of the corpus in cash," points out Akhilesh Gupta of Dundee Mutual.

Cash funds have also been helped by a burgeoning kitty, as investors poured money in these funds amidst uncertain equity and debt markets. In July alone, investors poured over Rs 5 billion in cash funds. The new inflows have only helped the funds lend a larger amount in call money and earn higher returns. "The last couple of months has seen those funds emerge on top, which have had a higher allocation to cash," adds Gupta.

Source: Value Research

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