Experts are recommending short-term income funds ahead of the monetary policy review by the Reserve Bank of India (RBI). According to Value Research, a mutual fund tracking entity, short-term income funds as a category has delivered 0.92% in the past one month ended January 17.

With WPI declining to 6.16% for December 2013 compared to 7.52% for November 2013 — though the RBI is not expected to cut rates in the upcoming monetary policy review — it may give an indication of lower rates in the near future. Hence, experts advise investors to gradually take exposure to short-term income funds to benefit from high yields due to a seasonal liquidity crunch in February and March.

Yields move up in February and March due to tight liquidity. Short-term income funds can be looked at to capture this spike in yields. Invest with a minimum ninemonth time frame.

Short-term bond funds are also expected to benefit from a possible fall in interest rates in the next financial year. “We don’t expect rate hike in the upcoming monetary policy review. Rather, we expect the monetary policy orientation to move from curbing inflation to boost growth.

If interest rates start declining, short-term income funds may show some capital gains to investors. It is an old prescription to invest in long-term gilt funds and long-term income funds to benefit from interest rate fall. The impact of declining interest rates is the most when the fund is holding longterm bonds. However, individual investors are not really keen on betting their money on longterm bond funds.

Memories are still fresh of the losses they suffered due to volatility in interest rates in June 2013, when the yields moved up. Short-term income funds generally have low exposure to government securities with low duration, which reduces risk.

An average maturity of portfolios of short-term income fund hovers around a year against 10 years for that of the mid- and long-term gilt funds. This ensures that the shortterm income fund NAV (net asset value) does not fall as much as a long-term gilt fund in case interest rates were to move up, contrary to the expectations. Experts feel these funds are much less risky compared to long-term bond funds.

These funds won’t test the patience of investors the way long-term gilt as well as income funds do.