Investors have poured money into debt mutual funds in the last six years, attracted by higher yields and better tax efficiency, which in turn has expanded the pool of funds available for companies raising money through debt instruments.

Mutual fund investments in corporate debt through short-term and corporate bond funds have risen tenfold from 13,945 crore in the fiscal year ended March 2009 to 1.40 trillion in March 2015, according to data sourced from Value Research, a mutual fund tracking firm.

Fund managers say more and more money is being made available for investments in debt mutual funds buying corporate paper as retail investors move away from traditional investments such as fixed deposits and seek higher yields which are tax-efficient. This, in turn, has made borrowing cheaper for companies.

Dhawal Dalal, executive vice-president and head (fixed income), DSP Blackrock Investment Managers Pvt. Ltd, who manages about 20,000 crore of assets, said prospects of benign interest rates, declining fixed deposit rates and recent changes in the taxation period of long-term capital gains may have drawn retail investors into short-term income funds.

“Income funds other than liquid and liquid plus funds have also grown by a compounded annualized rate of around 30% in the last three years," he said, adding that the debt market has helped companies reduce borrowing costs.

Sujoy Das, director, and head fixed income at Religare Asset Management Co. Ltd, said investors are now more open to staying invested for a two- to three-year time frame in debt funds because such funds offer them returns higher than bank fixed deposits and staying invested for a longer time also allows them to save tax.

In his budget speech in February, finance minister Arun Jaitley said short-term capital gains would be levied if the holding period is less than three years, up from one year previously. This extinguished the tax advantage debt funds had over fixed deposits over a year but also ensured that investors chose to stay invested for a longer term. Fixed deposits have no such tax advantage if money is invested for three years or more.

“With investors staying invested for a longer term, fund managers are now more comfortable in taking investment calls on corporate debt. Besides, bank base rates have not come off as quickly as corporate paper rates, which means this is a cheaper source of funding for companies," said Das, who manages about 22,000 crore of funds for his firm.

For example, State Bank of India (SBI)’s base rate has come down from 10% a year ago to 9.70% now, down just 30 basis points.

In comparison, the one-year commercial paper yield has dropped 109 basis points to 8.36% from 9.45% a year earlier, Bloomberg data shows. One basis point is one-hundredth of a percentage point.

Companies raised a record 4.32 trillion by private placement of corporate bonds in the year ended March 2015, up 60% from the 2.71 trillion raised in the year ended March 2014.

The tax inefficiency of fixed deposits and the sharp drop in interest rates banks pay on them, particularly in the last one year, means that debt funds will continue to attract money, fund managers said.

SBI pays 7.50% on a one-year fixed deposit currently, down 150 basis points from the 9% it offered a year ago.

Sandeep Bagla, associate director at Trust Capital Services India Pvt. Ltd, a bond arranger, said money is moving towards the bond market, which is a trend here to stay.

“Though the demand is more for AAA-rated and shorter-duration securities, there is also a market developing for lower-rated securities because of the higher yield it offers and also as fund managers take a bet on improvement on their ratings, which helps them take advantage of an increase in the bond price," Bagla said. Bond yields and prices move in opposite directions.

Santosh Kamath, managing director and chief investment officer, fixed income, India at Franklin Templeton Asset Management (I) Pvt. Ltd, who manages around 42,000 crore in assets, said more and more companies are accessing debt markets, giving fund managers a diversity of choice.

“Diversity means the choice is easier as fund managers can choose the type of industry or the structure they want to see in their bonds. This is a big change from a few years ago," Kamath said.

Money managers expect funds to keep coming into debt markets, particularly as the local equity market has hit a threshold and investors look for liquid investments which offer attractive returns.

India’s benchmark stock index, the S&P BSE Sensex, has fallen 0.48% so far this year after rising 30% in the 12 months ended December 2014.

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