Volatility Risks? Make Short-Term Investments

At the beginning of 2013, I invested in Templeton India Government Securities Fund - Long-Term Plan. I had planned to remain invested in the fund till February 2014, but have been disappointed by its performance. Should I hold my investment till February or switch to another fund? 

- Deepak, Bengaluru

This is surely not a commonly held fund, and is meant for those who know their bond markets well. It is a great fund for taking a quick call on the G-Sec market given that it has no exit load, but comes with its attendant risks.

The fund presently maintains a portfolio of G-Secs with a modified duration of 8.42 years (as on Ocober 31, 2013). This means that the portfolio effectively behaves like a single bond which matures 8.42 years from now although it has bonds of differing maturities. 8.42 years is a fairly long duration. Even a small change in the present interest rates or an anticipation of change will make the fund’s NAV swing, resulting in volatility. Since the time you invested in January 2013, the interest rates have moved up and there was a great deal of uncertainty on the monetary policy given the weak rupee and rising inflation. The NAV chart of this fund below illustrates the resultant swings it has gone through.

You have another 90 days or so before you need this money and the fund has not made any money in the time period that you have invested (-0.81 per cent) in it. What can happen in the interim? Among the known factors, we have the next monetary policy coming up in December. In September, the headline Wholesale Price Inflation (WPI) rose to an eight-month high of seven per cent (on an annual basis), which oversteps the RBI’s comfort zone of five per cent.

As shown in the chart, the Consumer Price Inflation (CPI) also rose by double-digits in September. The RBI expects the WPI inflation to exceed the current levels for the rest of the current fiscal, while CPI inflation is projected to remain above nine per cent. With rising inflation (CPI), there is a likelihood of a further increase in rates, which is bad for your investment. If there is a hold, the markets would likely feel better. While the CAD seems under control for this year, pressure on the currency can still come in due to importer demand or FII outflow. Tapering by the Fed is not likely to begin so soon, but each time there is a rumour of it, the rupee suffers. Unless you are confident of falling rates in the interim (unlikely), there is no point in holding this fund now. You might as well shift to a liquid or ultra-short term fund and cut the downside risk.

You could invest in funds such as Templeton India Ultra Short-Term Fund, Templeton Floating Rate Income Fund and Templeton India Low Duration Fund. Templeton India Government Securities Fund is unlikely to add value to your portfolio in the near-term as your holding period is quite short.
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Templeton Ultra Short-Term Fund and Templeton Floating Rate Income Fund are money market funds, while Templeton India Low Duration Fund is a conservative short-term fund. The funds generally maintain a low modified duration to minimise interest rate sensitivity, while offering relatively higher accruals. The chart shows that these funds have outperformed Templeton Government Securities Fund in 2013 and have generated relatively more stable returns. Furthermore, they are among the best performers in their respective categories.

In October, these funds had invested in short-term corporate bonds and money market instruments such as commercial papers and certificates of deposits. The table shows that they have durations which match your investment horizon.

You can redeem your investment in Templeton India Government Securities Fund and simply do a switch-in to any of the three funds discussed. This would be simpler and faster than shifting your investments to a different fund house.

Remember that investments in debt funds will incur Dividend Distribution Tax (DDT) or Capital Gains Tax (CGT). Your tax liability will be determined by your tax slab and the investment option that you choose. If you fall in the highest tax bracket, the Dividend option may be more tax-effective as you will have to pay Capital Gains Tax of 30 per cent (plus cess) if you choose the Growth option. However, you should choose the ‘Growth’ option if you pay tax at 10 per cent or 20 per cent.