Winter’s over: It’s springtime for shorter-horizon funds

The Covid winter seems to be finally ending for debt-oriented mutual fund (MF) schemes as interest rates peak, especially for those that invest in shorter-maturity papers.

In the past two months, shorter-horizon debt schemes — ultra-short, low-duration, and money-market — have together raked in net inflows of Rs 48,000 crore, the highest for two months since April-May 2021.

These schemes invest in shorter-maturity papers ranging from three months to a year.

Owing to the shorter duration, these schemes’ interest-rate risk is lower than longer-horizon debt schemes.

These schemes are used mainly by institutional investors and high networth individuals (HNIs) for short-term investments.

Senior industry executives attribute the surge in inflows to improving investor sentiment on the back of a pause in interest rates, improving liquidity, and cooling inflation.

“Over the past few months, investors saw attractive short-term interest rates and comfortable liquidity, and with markets believing we are near the end of a rate hike, there was a pick-up in net sales in shorter-maturity schemes,” says Sirshendu Basu, head-products, Bandhan Asset Management Company (AMC).

“A few things have changed in the current quarter.

“Core liquidity has improved significantly owing to the roll-back of Rs 2,000 denominations and foreign exchange intervention by the central bank.

“Also, owing to seasonality, the first quarter (Q1) does see increased flows from institutional investors.

“Another important reason is that the fourth quarter saw a high supply of issuances, leading to higher yields.

“This phenomenon normalises in Q1. Overall, views regarding inflation and rate hikes are relatively positive now.

“The sum of the above factors has buoyed up spirits,” says Aashwin Dugal, co-chief business officer, Nippon Life India Asset Management.

The fact that these schemes have delivered good returns (roughly 7 per cent) in the past year is also expected to have attracted retail investments.

MF executives expect inflows into shorter-horizon funds to remain elevated in the near term.

They expect these schemes to retain their advantage over mid- to longer-horizon schemes like corporate bonds, gilts, and medium-duration funds until the rate-cut cycle nears.

In its latest monetary policy review, the Reserve Bank of India maintained its policy stance as ‘withdrawal of accommodation’ and underscored its focus on bringing inflation down to 4 per cent.

Since inflation remains considerably above this threshold and the policy differential with the US remains low, the market is not expecting rate cuts, not this calendar year.

In a rate-cut scenario, longer-horizon schemes become appealing.

They are better equipped to capture the capital gains arising out of rate cuts.

As of now, most mid- to longer-horizon schemes are continuing to struggle to gather inflows as they fail to offer any extra incentive (by way of higher yields) to investors to compensate for the higher interest-rate risk.

In addition, investors no longer get any tax benefits for staying invested for a longer duration in debt schemes.

The yield-to-maturity (YTM) of debt schemes across horizons has been in a narrow range for some time now.

The end-May YTMs of most debt schemes, except for credit risk funds, are between 6.8 per cent and 7.4 per cent.

Gilt funds, which invest in longer-term papers, have lower YTMs (an average of 7.08 per cent) than shorter-horizon schemes like money-market funds (an average of 7.2 per cent).

Most debt fund managers are also keeping the duration of their portfolios on the lower side of the mandate due to the current market scenario and other prevailing factors.

“Given the sizeable inflows after the change in debt taxation announcement, we had tactically added long-duration assets.

“Now that the call has played out, we have shifted to the shorter end of the curve,” says Manish Banthia, chief investment officer, fixed income, ICICI Prudential AMC.

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