Short-term debt funds may gain favour amid dovish rate outlook

Mumbai: Investors could allocate a large portion of their fixed-income portfolios to accrual strategies-an approach that aims to earn returns from interest receipts rather than capital gains-in the wake of the Reserve Bank of India‘s dovish outlook for interest rates. Fund managers said that with the 25-basis-point rate cut on Friday, taking the total rate cut tally to 125 basis points this calendar year, investors may need to lower return expectations, as the scope for capital appreciation has diminished.

“Investors should continue to focus on investing in portfolios positioned at the short end of the curve running accrual strategies such as low duration, money market, and liquid over the next 2-3 months,” says Dhawal Dalal, chief investment officer, Edelweiss Mutual Fund.

Investors with less than one-year horizon may consider liquid and money market funds offering 5.75-6.5%, while those with a 1-2 year horizon could look at short-term funds with potential returns of 6.5-7%.

“An easing transmission cycle and softer liquidity conditions create a favourable backdrop for short to medium duration strategies,” says Anurag Mittal, head of fixed income, UTI AMC. Investors with a horizon of more than one year may consider short-duration and corporate bond strategies.

The fixed income investment strategies fall into two main buckets: accrual and duration. Accrual strategies primarily earn from the interest paid by the bond, and are less affected by rate movements. In duration investing, investors aim to make money from capital gains in bonds when they move in reaction to interest rate moves. Duration funds bet on long-term bonds like government bonds with a maturity of 10 years and above. However, if rates rise, long-duration bonds can fall in value, making these strategies better suited for investors who can time the market.

With the RBI cutting interest rates in the past year, fund managers believe a bulk of the easing is over. This means bond prices may not rise meaningfully from here.

While the market does not completely rule out one more 25 basis point cut, fund managers believe the central bank has already used most of its policy room.