Moneycontrol
Dec 26, 2016 09:04 AM IST | Source: Moneycontrol.com

Debt funds you should buy for stable gains in 2017

Investment analysts and advisors feel long-duration bond funds could show good returns in the coming months, with RBI likely to signal softer interest rates.

Sarbajeet K Sen
Moneycontrol

If you are looking to park your money in fixed income for gains in 2017, you can consider investing in long-duration debt funds which are likely to benefit from falling interest rates.

Investment analysts and advisors feel long-duration bond funds could show good returns in the coming months, with the Reserve Bank of India likely to signal softer interest rates.

“Falling rate favour long-duration bond funds since they enjoy higher price changes for smaller changes in interest rates. On the other hand, funds in the shorter end of the curve will be affected less by rate changes. The only catch for long term investors investing in long term bonds is that they have to reinvest forthcoming coupons at lower rates which results in lower YTM,” Vijayananda Prabhu, Investment Analyst, Geojit BNP Paribas, told Moneycontrol.

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

Manoj Nagpal, CEO of Outlook Asia Capital, also favours long-duration bond funds along with dynamic bond funds. “Higher liquidity in the banking system will remain longer than expected and credit offtake is likely to be sluggish in the next 12 months. Hence, banks will continue to reduce interest rates on deposits and the re-investment risk increases during the next 12-18 months. At the same time, the current pause in cut in interest rates continues to provide investors with a suitable time to invest in long-duration debt funds and dynamic bond funds,” he said.

Dynamic Bond Funds invest in the debt market when the fund manager thinks it appropriate. The fund manager would buy and sell debt instruments as per market movements and the interest rate outlook.

Prabhu advises holding a mix of duration and accrual funds. “We have been recommending our debt fund investors to have a balanced portfolio of Accrual and Duration funds in their portfolios to protect downside from any surprises. A fine mix of Duration and Accrual funds will help in generating optimal returns,” he said.

He suggests a 3-year holding period for bond portfolios. “Since easier interest rates are inevitable in the long run, one could adopt a 60-40 Duration-Accrual strategy to benefit from current corporate yields and future rate cuts. These portfolios could be held for a 3-years horizon till rates bottom down and redemption turns tax efficient,” he says.

The focus of Accrual Funds is earning interest income from debt investment while duration funds look for capital appreciation as well in a falling interest rate scenario.
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