The Reserve Bank of India's move to cut interest rates is likely to make short-term income funds and dynamic bond funds more attractive. It will, however, take away a bit of sheen from fixed maturity plans (FMPs) — one of the most popular debt instruments preferred by rich investors when the interest rates are high. On Tuesday, yields of the 10-year government bonds slipped by about 10-12 basis points to 8.34% post the policy announcement. The yields for money market instruments, on the other hand, fell anywhere between 20 bps and 25 bps.
"With the rate reduction, liquidity conditions in the overnight market will improve. Hence, the yields of all near-maturity money market instruments will come off," said Sujoy Das, head – fixed income, Religare MF.
According to Mahendra Jajoo, CIO, fixed income, Pramerica Asset Managers, the short term yields for money market instruments such as commercial papers and certificates of deposit are likely to come off by 50-100 basis points over the next couple of months. The reduction in short-term rates will benefit investors in short-term income funds. "We have been consistently recommending investors to look at the 1-3 year mid-maturity space given that interest rates are likely to fall. Investors with a moderate risk appetite will therefore merit from short-term funds and retail-focused regular savings funds," said Chaitanya Pande, head - fixed income, ICICI Prudential AMC. Added Das: "Income funds with average maturity of about one year are likely to give superior returns."
Another category of funds that is likely to do well is dynamic bond funds, said market participants. While interest rates seem to have peaked, it is difficult to determine when the next rate cut will be. Uncertainties with respect to inflation, global economy and currency movements are likely to persist. So, there is likely to be a fair amount of volatility in the money market, as well as government and corporate bond markets. Dynamic bond funds are well-suited to ride this volatility as they have a flexible duration and can invest in a mix of instruments, said industry observers. Dynamic bond funds are also ideal for those who don't want to take a call on interest rate movements.
The reduction in interest rates is likely to make FMPs less popular. "FMPs will become slightly less attractive because of the steep rate cut but there will still be a market for these products given the high interest rates," said Das. One-year FMPs that were giving returns of 10%-plus in March are now likely to fetch 9.5%, said market participants. Between October and March this year nearly 500 FMPs were launched by fund houses.
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