Mumbai: Managers at mutual funds (MFs) are beginning to refocus on equity as yields on debt instruments such as certificate of deposits (CD) and commercial paper (CP) witness a sharp decline.

The returns to equities is an about turn from earlier this year, when falling equity prices had sent mutual funds running to the safety of debt papers.

Better investment: The Bombay Stock Exchange building. While yields on debt instruments have been falling in the past six months, the 30-stock bellwether Sensex index has gained at least 49% since April. Abhijit Bhatlekar / Mint

At the end of June, the 35 mutual funds in the country had average assets under management of Rs6.7 trillion, according to data from the Association of Mutual Funds of India (Amfi).

During the April-June period, allocations into debt instruments have grown from Rs3.18 trillion to Rs3.37 trillion, while investments in equity instruments have surged from Rs98,132.36 crore to Rs1.29 trillion.

This is in sharp contrast to the investment pattern in the January-March quarter. In January and February, investments in debt instruments grew by 11.26% to Rs2.64 trillion at the end of February, while investments in equity instruments declined by 5.8% to Rs76,716.25 crore.

Though investments in debt instruments fell marginally to Rs2.17 trillion at the end of March, this was because fund managers redeem most debt investments in that month to meet redemption pressures at the end of the financial year. The money redeemed in March is typically reinvested in April.

During the April-June period, allocations into debt instruments have grown from Rs3.18 trillion to Rs3.37 trillion, while investments in equity instruments have surged from Rs98,132.36 crore to Rs1.29 trillion. Ahmed Raza Khan / Mint

On the other hand, according to data from the Reserve Bank of India (RBI), interest rates on CDs have declined from a monthly average of 7.33% in January to about 3.40% in July.

Since April, the average rates on these papers have fallen by at least 300 basis points. One basis point is one-hundredth of a percentage point. Similarly, interest rates on CPs have dropped from 9.48% in January to 4.69% in July.

“The rates on CDs have dropped most sharply since June. This drop in yields may eventually impact the returns on funds that invest in such papers," said Amandeep Chopra, head of fixed income at UTI Asset Management Co. Ltd.

CDs are secured promissory notes of at least Rs1 lakh issued by banks or financial institutions to raise short-term funds, typically with maturity of one-three years. CPs are rated but unsecured debt instruments issued by companies as an alternative source of working capital. Typically, CPs have maturities of between one week and a year.

“Equity is a secular market. If earnings continue to grow, it will give better returns. On the other hand, fixed-income market is cyclical," said Sujoy K. Das, head of fixed income, Bharti AXA Investment Managers Pvt. Ltd. “With the credit policy giving warnings of food price inflation beginning to kick in, we expect to see yields beginning to harden in the next couple of months."

In February, when mutual funds were shifting their attention to debt from equity, A.P. Kurian, chairman of Amfi, had said that investors would return to the equity markets only after equities “start coming up in a sustained basis".

Liquid schemes, liquid-plus schemes and short-term bond funds—all of which allow investors of enter and exit quickly—are the largest investors in CDs and CPs, which hold around 80% of mutual fund investments in debt.

Balanced equity funds and hybrid equity funds also have the option of parking money in these debt instruments. To maximize returns, fund managers have the flexibility to choose among a range of debt and equity instruments during a given tenure.

“Returns are impacted when interest rates on any instrument decline. As the liquidity is high, the rates on debt papers are coming down. During such time, investors should look at short-term bond funds and liquid-plus schemes, where fund houses have the flexibility to invest both in short-term and long-term debt instruments," said an official at ICICI Prudential Asset Management Co. Ltd. He declined to be identified.

However, fund managers expect the rates on debt papers to rebound after the September quarter, which they say will see investments in debt instruments go up again.

“Most of the fund houses may start fresh rollovers of CDs from September. We expect the credit demand to pick up from the end of second quarter, which will require banks and financial institutions to look for more capital, with CD issuances," said Chopra of UTI Asset Management.

PTI contributed to this story.