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Interest rate goes up, invest in short-term debt funds


Short-term debt funds – flavour of the season
If you aspire to earn good returns during high interest rate scenario, then this is the right time to invest in short-term debt funds. RBI is struggling hard to combat bullheaded inflation. Interest rates are on their all-time peak.

The long-term interest rate facet is uncertain, with the rapidly changing macro factors – both local and international, crude prices being concerned and their overall impact on the fiscal situation. All these visual aspects provide an ideal arena to invest in short-term debt funds.


What are short-term debt funds?
Short-term debt funds are the fixed income securities that have maturities from 3 months to 18 months. These funds are offered by mutual fund houses as it is difficult for the retail investors to invest in these funds directly.

(If you want to know more about short-term funds, click here)

Where do these funds invest?
The fund managers of these funds park money in money market instruments such as certificate of deposits, commercial paper or treasury bills with the same tenure i.e. instruments maturing on or before the maturity date.

Why to invest in these funds?
Short-term debt rates have peaked, due to RBI's anti-inflationary stance and tight liquidity scenario. At present, one-year bank certificate of deposits (CDs) that carry the highest safety rating of P1+ are at the levels of 9-10%, while two and three-year maturity triple-A corporate bonds are all trading at the levels of 9.5% to 9.6%.

Yields of short-term corporate bonds in the span of last one year rose by almost 250 basis points (bps) from 7% to 9.5%. This is due to tight liquidity and multiple rate hikes by RBI.

Currently, there is uncertainty over the long-term interest rates as inflation is still beyond the RBI's comfort zone. Due to prevailing high inflation, upward pressure on the rates will remain and with the prospect of leveraging the inflated rates at the short end of the curve, investing in short-term debt funds can be a lucrative option.


(Also read: Investment strategies during high inflation and high interest rates scenario)

OneIndia Money

Story first published: Thursday, July 28, 2011, 15:02 [IST]
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