Bond rally boosts debt funds but small savings rate may fall

NEW DELHI: Equity investors are making handsome profits but debt investors aren't far behind.


With bond yields falling to a 20-month low, long-term debt funds have rallied in the past week. The 10-year government bond yield dropped below 8% on January 1, over 70 basis points below the peak in early April 2012. While the drop in bond yield has boosted returns of debt funds, it could translate into lower rates on small savings schemes such as Public Provident Fund ( PPF), National Savings Certificate ( NSC) and Senior Citizens' Saving Scheme.

The consensus estimate on Bloomberg is that the 10-year bond yield will fall to about 7.95% by March and slip further to 7.77% by December before recovering to about 8.01% in March 2014. "If the RBI cuts rates by 50 basis points at one go, the benchmark yield could fall to 7.75%," says Avnish Jain, senior fund manager for fixed income, ICICI Prudential Mutual Fund. Here's how this will affect investors:

DEBT FUNDS

Long- and medium-term debt funds have rallied but experts believe this will not sustain. Due to volatility in bond yield, short-term debt funds had outperformed in the past 2-3 years. But in the past 3-6 months, long-term bond funds have done better than short-term funds. This trend may continue till yields stabilise at about 7.85%.

"Investors should stick to dynamic bond funds that can quickly change the average maturity of their holdings," says Mahendra Jajoo, head of fixed income, Pramerica Mutual Fund.

FIXED DEPOSITS

The RBI is expected to cut interest rates this month, which could make banks reduce their deposit rates. If you want to gain from the high rates, lock your money in a fixed deposit right away. If you don't have enough surplus cash, go for a longterm recurring deposit.

Once you lock in, the interest rate stays unchanged for the entire term of the deposit . The longest term offered by banks is 10 years. The prevailing 10-year fixed deposit and recurring deposit rate is 8.5-9 % but could come down to about 7-7 .5% by March.