Those looking for safety and smooth returns from bond schemes like their fixed deposits, would be disappointed again

On 16^th July, the Reserve Bank of India (RBI) tightened domestic liquidity to stem the rupee depreciation. As a result, banks started redeeming their surplus investments from liquid and gilt schemes of mutual funds. Mutual funds were net sellers of Rs12,546 crore, whereas FIIs were net sellers of Rs263 crore in the debt market. On account of the huge redemptions, bond yields shot up by 54 basis points from 7.56% to 8.01%, the biggest single-day gain since January 2009. The average net asset value (NAV) of bond schemes (having an asset above Rs100 crore) declined by 2.07% in a single day. Over the past two months, bond yields have gone up to 8.1% as on 16 July 2013 from a low of 7.09% as on 24 May 2013. During this period bond scheme have delivered a return of -3.09%.
 

While regular bond schemes declined by 2.94%, the much-touted dynamic bond schemes declined by 3.46%. This would have come as a rude shock to bond fund investors. They look for safety and smooth returns when they invest in bond schemes; an alternative to bank fixed deposits.
 

Over a one-year period ended 16^th July, bond schemes delivered an average return of just 5.43% post tax – no better than bank FD. The top 10 bond schemes delivered an average post-tax return of 7.10% while the bottom 10 bond schemes delivered an average post-tax return of 3.74%. Dynamic bond schemes fared no better delivering an average return of 5.47% over the year. “Dynamic” is a marketing gimmick. Bond fund managers are incapable of timing the market since Central Bank can change the rules of the game overnight.
 

Considering that since April 2012, the RBI has cut interest rates by 125 basis points to 7.25% from 8.50%, this is not the kind of returns bond fund investors would be expecting. However, the massive sell off by foreign investors over the past month has led to a loss for bond fund holders. We are sure no Indian bond fund investors, bond fund managers or mutual fund companies had reckoned with this new factor – volatility in returns caused by FIIs entering and exiting the bond market. From the beginning of June to 15th July, FIIs have registered a net outflow of over Rs40,000 crore due to a changed outlook of interest rates in the US and the strength of dollar.