10Y G-SEC YIELD BELOW 8% and Mutual fund debt fund

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In its fifth bi-monthly monetary policy statement, the Reserve Bank of India left both the Repo Rate and Cash Reserve Ratio (CRR) unchanged .This was broadly in line with a majority of market participants’ expectations.

Market participants reacted favourably to the RBI’s dovish policy monetary stance and further lowering of March 2015 CPI target to 6% from around 6.5% earlier due to the recent decline in the crude oil prices. Predictably, government bond yields declined after the monetary policy statement as market participants have begun to factor in the first reduction in the Repo Rate by early 2015. The benchmark 10Y government bond yield declined from around 8.07% just before the announcement to below 8% after the announcement amid confirmation of the RBI’s dovish monetary policy stance. The key question in most market participants’ mind is – where do we go from here?

So how various categories of debt funds will work under this new Scenario and where you will have to rethink your investment strategy-

1. Ultra Short Term Funds

These funds are primarily utilized for your very short term or immediate goals. There is less thinking to park surplus beyond one year. Although in last few years the returns generated by this category has made investors thinking but the end objective of these funds is to ensure you can utilize the money when in emergency.  If your objective is investing your emergency surplus for few days to few months then not much has changed and one can continue investing in these funds.

2. Short Term Funds

This category is also considered for short term goals where one has 6months to 1 year horizon.  Although the long term taxation will now apply post three years investors in highest tax slab will have to rethink their strategy if considering for investing funds for a year.

3. Fixed Maturity Plans

This is the category which bears the biggest setback. The benefit of LTCG tax with and without indexation after one year was the main attraction giving higher returns than traditional fixed deposits. On other hand the double indexation benefit helped investors enjoy the lucrative gains by investing funds for a short period. But with new budget provisions no more there is a tax advantage in 1-3 year. Post implementation of this provision Investors who have considered FMPs for their medium term goals will find FDs attractive.

4. Monthly Income Plans

With a decent exposure to equities  Monthly Income Plans were considered for meeting regular income needs. Most retirees invest in these schemes for supplementing their other monthly income investments. Investment in MIPs followed by Systematic Withdrawal Plans after one year is the most preferred strategy for generating periodic income since long term capital gains taxation applied after one year. But the strategy will have to be reconsidered now. With long term definition extended to three years and 10% without indexation provision removed investors who took exposure in these funds for regular income needs will have to re-plan.

5. Dynamic Bond Funds

They were in news when interest rates were volatile. Dynamic bond funds did exceptionally well during such scenario and were lot more considered for beating the interest rate volatility by investors who do not have enough expertise to understand the interest rate scenario. But no more you can look at them for 2-3 years horizon. However, some of the funds from this category have been a good performer in a longer term, i.e. 5-6 years. In such investing horizon these funds still hold a good promise.

6. Income Funds and Gilt Funds

These funds are for long term investing and so one has to consider the for their long term goals. In the medium term these funds can be volatile which we have experienced in last few years. Not much changed in investing strategy for these funds if you are allocating your long term debt exposure to them. But if considered for less than three years to take advantage of interest rate movement, recalculate your net gains post new taxation.

There are many categories in debt mutual funds and not all will be highly impacted by the change in taxation rule. But few investors such as retirees who rely on these for meeting their income needs may have to rethink their investing strategy or even the alternatives.

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 "In investing, what is comfortable is rarely profitable."