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Have idle cash? Invest in bond funds

Tinesh Bhasin in Mumbai | December 19, 2008 12:03 IST

If you are sitting on idle cash, it's better to invest the same in income funds and earn over 10 per cent returns, say investment advisers. They believe that falling interest rates will jack up returns from bonds and investors can earn high returns if they deploy the money with a horizon of six months to a year.

The returns from interest rates and income funds are inversely related. So, when one falls, the other rises and vice versa. Income or bond funds invest in instruments such as bonds, debentures, government securities and similar debt market instruments. Investors who are risk-averse park their money in such funds.

"Many of our clients were sitting on cash. This money was withdrawn either from fixed maturity plans (FMPs) in October as they feared default or they booked losses in the stock market," says Sriram Venkatasubramanian, head, wealth management, Centrum FCH Wealth Management.

Investment experts are advising their clients to invest in medium- and long-term income funds to get maximum returns from rate cuts. "The longer the maturity period of papers in the portfolio, the better are the returns. Select a fund that has average portfolio maturity of at least seven years," said Ashutosh Wakhare, a mutual fund expert.

Ideally, the average portfolio maturity of medium-term bond funds is between three and five years. For long-term bond funds, the average maturity is over five years. In reality, the average maturity of both the schemes rises and falls according to the interest rate scenario.

Most of the advisers feel that interest rates will further fall. Centrum FCH feels that yields from 10-year government bonds (G-Sec) will come down to 5-5.5 per cent. Currently, the yields are about 5.98 per cent.

In fact, mutual funds have already seen inflows in long-term bond schemes rise sharply. "Many schemes' assets under management (AUMs) have risen by 50 per cent last month. Usually, these schemes have an average corpus of Rs 100 crore (Rs 1 billion)," says Parijat Agrawal, head, fixed income, SBI [Get Quote] Mutual Fund.

In fact, in September and October, income funds saw a net outflow of Rs 28,964 crore (Rs 289.64 billion) and Rs 33,169 crore (Rs 331.69 billion), respectively. In November, this category had net inflows of Rs 18,897 crore (Rs 188.97 billion).

Bond funds predominantly invest in papers issued by private companies, non-banking financial companies (NBFCs) and banks. They are considered risky as there is a chance of default. Conservative investors, who want to avoid this risk, can invest in gilt funds. These funds only invest in G-Secs.

But before you rush to put your money in these bonds, exercise caution, say financial advisers. They advise to look at the portfolio of the fund. "Portfolios that have papers of public sector companies such Rural Electrification Corporation and Power Finance Corporation [Get Quote] are safer. Investors should avoid funds that have papers of real estate firms and NBFCs," says Vishram Modak, a certified financial planner.

Income and gilt funds are open-ended funds and investors can opt either for dividend or growth option. The investor will pay a dividend distribution tax of about 14 per cent, if s/he opts for dividend option. In case of growth, s/he pays capital gains tax, depending upon the tenure of investments.

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