Short Term Mutual Funds are safe Investments

Many individuals, who had invested large sums in income funds between April and May 2013 on expectations of an imminent rate cut, are extremely disappointed with the paltry returns they got from these funds. Contrary to expectations, the Reserve Bank of India raised interest rates to rein in a depreciating rupee and income funds managed to return only around 4.7% last year.

With a host of uncertainties hovering around the money market, many financial pundits are asking investors to play it safe and sell a part of investments in long-term income funds and shift the money to ultra short-term and short-term funds with a maturity profile of 3-15 months, until a clear view emerges on interest rates. Investors with a low-risk profile and time frame of less than two years would be better off investing in ultra short-term funds or short-term funds.

Rates may not Come Down Soon

Money market analysts rule out a rate cut in the near-term, because of high food inflation and poor monsoon forecasts. Macroeconomic indicators also continue to remain poor. Data for the first 11 months of the last financial year (April 13-February 14) shows fiscal deficit rose 14.3% over the revised estimates of . 5.24 lakh crore. Consumer price inflation inflation, which is now the RBI's focus, continues to remain high and much beyond the RBI's comfort zone.

It rose to 8.31% in March from 8.03% in February, far above the RBI's comfort level of 8%. As per a report by Motilal Oswal Securities, initial predictions for the monsoon by the IMD are negative. It has assigned rather high probability of 33% for 'below normal' rainfall and 23% probability for a 'deficient' rainfall. It has also assigned 60% chance of an El Nino event that usually causes deficient rainfall. A poor monsoon will raise prices of fruits and vegetables, thereby raising inflation and could even push rates up marginally. Investors can invest in ultra short term funds such as HDFC CMF-Treasury Advantage Plan and DSP Money Manager Fund. Initial forecasts indicate the monsoon could be below normal. If inflation remains sticky and fiscal position worsens, interest rates could move up marginally. The 10-year benchmark that is currently trading at 8.80% could trade between 8.5-9.25%. If interest rates rise, it will lead to a fall in bond prices and it will cause losses for income fund investors.

Investors, who hold income funds with an average portfolio maturity of 3-5 years, stand to lose a lot. For every one basis point increase in interest rates, a five-year bond price could go down by 3-4 paise. So, if interest rates rise by 50 bps, investors in income funds could see their returns going down by 1.5-2%.

This is why advisors are asking investors to exit a part of their income funds they invested in last year and shift to short-term or ultra short-term funds. Ultra short-term funds have an average maturity of merely 3-4 months and they are less sensitive to any movement in interest rates, Ultra short terms gave a return of 9.05% last year, says Value Research, a mutual fund tracking firm.