Low-risk short-term bonds a big hit on D Street

MUMBAI: Low-risk short-term bond funds are outperforming the high-risk equities as companies keep raising their interest rates for funds due to tight liquidity and policy rate hikes aimed at containing inflation.

Kotak Floater LT, Birla Sunlife ST Opportunities and BNP Paribas Money Plus, which invest in short-term bonds, are among the top performing funds in the category with returns as high as 8% since November. The benchmark Sensex has lost 7.7% during the period.

"Investors with 3-6 months horizon should invest now as interest rates are high, so they can take advantage of higher coupon rates and the additional benefit of higher capital appreciation in the April-June quarter," said Nandkumar Surti, chief investment officer at JP Morgan Asset Management. Its short-term bond fund has seen inflows of 200 crore in the past month.

Returns from fixed-income securities are going up as interest rates are rising due to high demand for money and the hike in policy rates. With inflation at more than 8%, RBI is expected to raise another 100 basis points this year, after raising it seven times in the past 12 months.

Banks are offering record rates for deposits and triple-A rated companies' yields are at more than 9.5%. Some banks are borrowing at 10% as there is a liquidity crunch.

These funds invest in bonds and other fixed-income instruments of high quality and low risk that have a tenure of around one year to 15 months and are best suited for short-term investors. The portfolio comprises treasury bills, certificate of deposits, commercial papers, securitised debt and advances in the call money market.

"The yields on the shorter-tenure paper had surged due to which the interest in the category was limited, but as far as the rate cycle is concerned, the worst seems to be over," said Lakshmi Iyer, head-fixed income & products, Kotak Mahindra Mutual Fund. Equity issuance and advance tax outflows could put rates under pressure in March but the influx of liquidity from April will see the curve becoming steeper, which will reflect in the funds' improved performance, she said.

An investor looking to invest in these funds for less than a year should look at the dividend option for tax benefits. The dividends are taxed at 13.841%. Funds declare dividends on these schemes to ensure investors' gains are taxed at a lower rate, making the monthly dividend option more attractive for short-term investors. If the period of investment is more than one year, and the growth option is preferred by investor, gains will be taxed at the rate of 10% without indexation or 20% with indexation, whichever is higher. The interest earned in an FD will be taxed at 30.9% if the investor falls in the top-tax bracket.