Mumbai: The Reserve Bank of India’s (RBI) inflation-indexed bond linked to the Wholesale Price Index (WPI) has drawn mixed reactions from mutual fund (MF) houses.

The WPI bond, which has a coupon of 1.44%, was launched in June 2013 to give investors returns higher than the rise in wholesale prices. However, the bond prices crashed recently as RBI has shifted its focus to contain retail inflation. The total outstanding amount of these bonds is 6,500 crore, but the last auction for 500 crore had to be scrapped because the market asked for higher yields.

As a result, the prices of WPI bonds have crashed to 80 from a face value of 100. This indicates an implied interest rate, or yield of about 4% above WPI inflation. The last reading for inflation in January was 5.05%. Hence, an investor in these bonds will earn at least a 9.05% return—a seemingly attractive investment.

However, these bonds are not available for retail investors directly and one has to invest through MFs, something that some fund houses are hoping will lure in a lot of money before the fiscal year closes.

This view is not universal. While some fund houses want the bond for a low price, others want to stay away from it, fearing a further price drop in the absence of a liquid market.

Bond traders don’t trade on this bond any more, but there are some infrequent trades, mainly by fund houses trying to accumulate it. Banks want to get out of WPI bonds, given the steady drop in prices. In future, as everything gets measured in terms of consumer price-based inflation, this bond would likely become a dud and banks may not find buyers, they fear.

But those who don’t have any wish to sell this bond before its maturity in 2023 have no such worry. Investing through MFs has its own tax benefits as well, which is not the case with another inflation-indexed bond linked to inflation based on the Consumer Price Index (CPI). That bond, offering 1.5% above the CPI reading, is almost exclusively for retail investors. But it has failed to take off because of its tax implication, which is 30%. Fund houses are not allowed to tap into this bond, but they can buy the WPI bonds from the secondary market at a steep discount.

HDFC Asset Management Co. Ltd is bringing out a fixed maturity plan of nine years dedicated to WPI bonds. Another fund house, Deutsche Asset Management (India) Pvt. Ltd, has already an MF selling these bonds, while two more fund houses—SBI Funds Management Pvt. Ltd and Axis Asset Management Co. Ltd—have filed with the capital market regulator to float open-ended inflation-indexed bond funds.

Many fund houses have increased the share of the WPI bond in their portfolio. Recent MF data shows between September and January, SBI Dynamic Bond and SBI Magnum Income fund have increased the bond holding to 263 crore and 235 crore each, from 50 crore each in September. Various funds by ICICI Prudential Asset Management Co. Ltd have also increased the share of these bonds in January from almost nil in September. Fund houses of Kotak Asset Management Co. Ltd, Reliance Capital Ltd, etc., have also increased their share in these bonds.

In mid-September, the price of the bond was 84, but by the end of January, the prices fell to about 80, prompting MF houses to buy the bond. Data for February is not yet available.

However, not all are so enthused.

“The bond is attractive, but we are not buying more than what we already own because the bond is not very widely traded," said Lakshmi Iyer, head of fixed income and products for Kotak Mahindra Asset Management Co. Ltd.

Axis Asset Management, even as it has applied to float an inflation-indexed bond fund, is yet to buy the bond in any of its existing schemes.

“The bond is definitely attractive, but we don’t own it, and we aren’t buying it any time soon," said R. Sivakumar, head of fixed income and products, Axis Asset Management. He did not rule out the possibility of including this bond in the portfolio, but liquidity is a problem.

The average spread between WPI and CPI has been 1.1%, but recently has increased to 3.74%. This is because of elevated food prices that has a weightage of 47.1% in the CPI but 24.3% in WPI. A committee led by RBI deputy governor Urjit Patel recommended that the central bank should bring down the average CPI inflation to 6% by fiscal year 2014-15. Fund houses are betting that the fall in CPI may not be in sync with a fall in WPI because WPI has more weightage in fuel and metals, which are controlled by international factors.

Still, some fund houses are sceptical about the prospect of a WPI fund.

“One mutual fund house came to us to sell the WPI-linked product. After much deliberation, we decided against it. We were proven right because the prices fell from 83 to 80. If everything moves to CPI, the fund house may not find a buyer for the bond when they want to exit," said a wealth manager with a large foreign bank who did not want to be named.

anup.r@livemint.com

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