Moneycontrol
Jan 03, 2017 09:02 AM IST IST | Source: Moneycontrol.com

Gilt funds gain the most from demonetisation

Medium to long term gilt funds have emerged as the biggest beneficiaries of the demonetisation drive in the mutual funds space, with the category delivering the highest average return of 15.58 percent in 2016


Medium to long term gilt funds have emerged as the biggest beneficiaries of the demonetisation drive in the mutual funds space, with the category delivering the highest average return of 15.58 percent in 2016.

"Towards the end of the year, yields came down sharply due to demonetisation," said Lakshmi Iyer, head, fixed income and products, Kotak Mahindra Mutual Fund.

“This created a huge liquidity overhang bringing down the rates," she said.

Bond yields have fallen by 150 basis points or 1.5 percentage point in the last one year. This has resulted in capital gains for these funds. In the last two months, the 10-year benchmark yield fell to 6.516 percent from 6.799 percent.

Generally, gilt funds benefit the most in a falling interest rate regime as bond prices are inversely proportional to the interest rates.

So, when yields fall, bond price rises and the rise in bond prices move up the net asset value or NAV of debt funds. Any drop in yield will result in capital gains for investors.

Another category that was benefitted due to falling interest rates is dynamic bond funds. This category was the second best performer with an average return of 13.41 percent in the year gone by. Falling rate favours dynamic bond funds since they enjoy higher price changes for smaller changes in interest rates.

In the previous review of the Monetary Policy on December 7, RBI Governor Urjit Patel kept repo rate unchanged at 6.25 percent while stating the central bank was “retaining an accommodative policy stance.”

Among other debt funds, ultra short-term funds posted 8.57 percent average returns, while liquid funds fetched 7.50% average returns last year.

Among sectoral equity schemes, banking-sector linked funds delivered the highest average return of 12.17 percent among in 2016, beating other categories such as pharmaceuticals, IT, FMCG and infrastructure.

In comparison, the benchmark NSE Bank Index gave 5.71 percent. Fund managers attributed positive returns from banking funds to demonetisation.

Last month, fund managers also increased allocation to bank shares on the back of demonetisation, as the cash in circulation that will be converted to bank deposits, will make banks the biggest beneficiaries of the move.

Shares of most state-owned banks did well in a weak market post-demonetisation because of surge in deposits and falling treasury yields. Bank of Baroda gained 6 percent, Bank of India put on 5 percent and Canara Bank, 2 percent. A boost to cashless transactions is also good for the banks as the sector dominates the retail payment system.

The worst hit category was pharma funds that delivered negative average return of 12 percent last year. Pharmacuetical sector has been reeling under regulatory issues and pricing pressures. Over last one year, USFDA has made adverse observations and issued warning letters to many drug makers. Some companies have faced temporary bans and some were forced to withdraw products

“Pharma stocks are under pressure because of warnings from USFDA,” said Gopal Agrawal, CIO, Mirae Asset Global Investments.

“There is also pricing pressure in the US market and concerns over Trump’s (expected) policies,” he said.
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