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Bond funds post phenomenal gains

Value Research

Call it the debt fury! Just a day after the cut in rates on small saving instruments, the Reserve Bank of India slashed the bank rate by another 50 basis points, thus bringing it down to 7 per cent. The bond market has rallied further with a never-ending flow of positive news, which started with State Bank of India's India Millennium issue. After the second round of bank rate cut on March 1, fund managers have set their eyes on a cash reserve ratio reduction in early April and a cut in US interest rates.

Returns are already flowing from the barrel of bond funds, which were greeted by a slew of budgetary sops on Wednesday. Riding high on the 100-150 basis points on small savings, the bond funds posted an average whopping gain of nearly 0.40 per cent on Wednesday. While such returns are surely not sustainable, it translates into an annualised gain of 146 per cent and amply reflects the surging bond prices. In fact, the top gainer for the day was PNB Debt Fund, which came close to posting a one per cent gain on Wednesday. Now, with the bank rate cut, returns will zoom further.

"It is not a never-ending party and this period of abnormal returns will come to an end. The prices are expected to consolidate at current levels. With the slew of incentives, inflows into bond funds are going to get a big boost," says Rajiv Anand at ANZ Grindlays Mutual Fund. "The market was expecting the cut and now that it is come, it will take a breather with some profit-booking," says Dhawal Dalal at DSPML Mutual Fund.

The Budget slashed the dividend tax on debt funds from 22 to 10.2 per cent. At the same time, the Budget brought down the section 80L limit from Rs 12,000 to Rs 9,000. This means that interest income (typically from bank deposits) only up to Rs 9,000 will now be tax-free against Rs 12,000 earlier. Further, interest income from bank deposits above Rs 2,500 will be now subject to tax deduction at source (TDS), which was earlier at Rs 10,000. And last but not the least, the falling interest rates will now force banks to cut their deposit rates and this will make bond funds more attractive, for they supplement their interest income with trading profits.

"Since banks have to meet mobilisation target for the current year, the cut in deposit rates will come only in the new fiscal," said Akhilesh Gupta at Dundee Mutual Fund.

While fund managers see a smooth sail going forward, they are sticking to the current maturity profile and not raising it further. "When the going is so good, a mild tremor can rock the boat. While we have made the most of the current rally, it is time to exercise restraint as normalcy returns," says a fund manager.

Debt funds are also not adopting an ultra aggressive investment strategy due to year-end concern. Last year, debt funds had seen heavy redemption as the fiscal drew to a close by big-ticket investors. Since most of them were fully invested with a reasonable maturity, it had led to a heavy selling pressure and pulled down the net asset values.

"While gilts have rallied, triple A bonds have not gone up as sharply, thus leading to a higher spread of around 100-110 basis points. While the yield on triple A paper is very attractive, we are not investing there due to liquidity concerns. Instead, we are parking money in liquid gilts and get into the corporate segment later," said Dalal at DSPML AMC. "Adds Anand at ANZ, "Unlike last year, funds are lot more prepared this year. And as opposed to the hike in dividend tax last year, it has gone down this year and hence the situation may not be that bad this year."

Manna from Heaven!

	Net asset	value	Returns	per cent
	February 27	February 28	1-day (%)	Annualised
PNB Debt	12.78	12.90	0.94	342.72
K Bond Deposit	11.63	11.72	0.83	301.34
IDBI Principal Deposit Bond	10.97	11.06	0.82	298.33
JM Liquid	18.07	18.18	0.61	222.19
ANZ Grindlays SSI	10.83	10.89	0.55	202.22

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